Wednesday, October 13, 2010

Link between the price of corn and the price of beef and pork---Your " Baconator" at Wendy's is about to increase in price...better get it today!

Meat Market Corn Crunch Means Costliest Beef in Quarter Century
""Meat prices are poised to extend a 14 percent rally this year that drove U.S. retail costs to the highest levels since the 1980s as surging corn futures prevent livestock producers from expanding their herds.""
Corn is a necessary input that goes into raising cattle and hogs. If the price of an input increases then the cost of producing the final product will increase as well (assuming other costs are not cut to balance it out).  Example: Assume current market equilibrium price for a pound of beef and/or pork is $1.00 per pound ("lb") and the current equilibrium quantity (quantity demanded = quantity supplied) for beef/pork is 100 lbs. Embedded in the market price of $1.00 is the cost of all the inputs and a "normal profit" earned by the rancher.  This is shown in the graph below:
Now, assume the price of the corn feed increases by $.50 per pound of meat produced.  This means to produce the same 100 pounds of meat, the cost (price) is going to increase by $.50. So 100 pounds of meat will cost $1.50 to produce. What is true at 100 pounds is going to be true at ALL quantities of beef/pork supplied. At any point on the current supply curve we can add $.50 to the cost (price).  If we do that at every quantity supplied we will have a shift of the supply curve to the LEFT, indicating a DECREASE in supply ("Supply 1"). See graph below:

We cannot ignore out market demand curve!!  As the supply curve shifts to the left, we move along our demand curve up and to the left until we reach a new market equilibrium at $1.25 (NOTE: On the graph above I have "P1" at $1.50. IT SHOULD be $1.25 NOT $1.50!!).  Our demand curve tell us that at $1.00 our quantity demanded was 100 pounds of meat, BUT at $1.25 our quantity demanded is 75 pounds. This is consistent with the Law of Demand (price varies inversely with quantity demanded).

The food chain continues. Beef and pork are inputs into making a "Bacon-ator".  Well, I don't have to tell you what is going to happen to the market price of that bad boy!...Unless Wendy's (1) counters the increase of beef/pork with efficiencies and/or cutting some other cost or (2) takes a reduction in profit, then you will pay more for that menace to health and well-being in America.
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