Why Retail Food Prices Swing Less Than Farm Prices

In 2011, the Producer Price Index (PPI) for farm products rose by 23.6 percent, but retail food prices rose by only 3.2 percent. Prices along the food chain move in the same direction, yet each stage swings by less than the one before it, and retail prices follow late. USDA's Economic Research Service (ERS) explains why.

Forecasting the grocery bill

Forecasting the prices consumers will face in the grocery store is one of ERS's most visible food price research activities. In 2013 ERS expanded its Food Price Outlook forecasts to include projections of the PPI for a select group of farm commodities, food products and wholesale commodities. Because the PPI can give an early signal of changes in retail food prices, it has long been an input to ERS's forecasting model, and forecasts for 13 specific PPI categories are now published each month.

The PPI measures the average change in prices paid to domestic producers for their output through each stage of production. The Bureau of Labor Statistics publishes the aggregate PPI, compiled from data covering nearly every industry that produces goods. Two sub-indices matter most to the food sector: the Farm Products PPI, which measures the annual percent change in prices paid to farmers for their commodities, and the Processed Foodstuffs and Feedstuffs PPI, which measures the change in prices paid to food processors for their products.

Price changes shrink at each stage

Comparing annual price changes for farm and wholesale food products with retail inflation, measured by the Consumer Price Index (CPI) for All Food, shows how price changes pass along the chain. The three move in the same direction but by different amounts.

The beef and veal category and the dairy category show a similar pattern.

Price swings for farm products and processed foods and feeds are larger than retail food price fluctuations in general. Image from ERS's page.

The same pattern holds for specific commodities and food products. Image from ERS's page.

Why retail prices are steadier

Retail prices reflect the cost of processing and marketing inputs as well as commodity costs. ERS's 2011 Food Dollar Series reports that just 10.8 cents of every food dollar goes toward farm commodities and agribusiness expenses. The rest pays for food processing, food service and other administrative, transportation and retailing costs. These categories are less volatile because of fixed machinery expenses, multi-year supply contracts and small year-to-year changes in wages. Since 1990, grocery store wages, which make up over 50 percent of retailing costs, have increased an average of 2.2 percent per year.

Costs for food processing and food services dominate food dollar costs. Image from ERS's page.

Timing: retail prices lag

The stages also differ in timing. In July 2012 the Farm Products PPI increased by 5 percent. Retail prices did not show a rise until August, and a much smaller one: the CPI for all food climbed by 0.2 percent. The lag suggests that retailers and restaurateurs are sometimes slow to pass input costs on to consumers, which can narrow their margins when commodity prices are rising quickly. Delayed price transmission in grocery stores can have several causes, including re-pricing costs such as printing new shelf labels and worry that input price changes are only temporary.

A 2011 ERS study found that retail prices for bread and beef generally respond to changing commodity prices within 1 to 6 months. Lags for some foods, such as eggs and milk, are at the upper end, 5 to 6 months.

Retail price changes lag input price changes. Image from ERS's page.

More information on food prices and ERS's forecasts is in the Food Price Outlook data product.

Sources

• USDA Economic Research Service, Food Price Transmissions From Farm to Retail; drawing on ERS's Food Price Outlook and Roeger and Leibtag (2011), How Retail Beef and Bread Prices Respond to Changes in Ingredient and Input Costs, ERS report ERR-112; rewritten in hubnx's own words.