Lee Schulz - Extension Ag Economist - Iowa State University
SUPPLY AND DEMAND: Market economics views the idea of a shortage in different terms. There is conflict between what the consumer wants and what producers are willing, and often able, to supply.
Shortage is a nebulous concept that means different things to different people. Consumers may see a shortage of 99-cent-per-pound ground beef. But if a shortage of ground beef at $4.99 per pound exists, it is much smaller than the shortage of the 99-cent product.
Economics views the situation in terms of scarcity. That is, consumers want more of some products than producers are willing, and often able, to supply at a given price. This conflict between society’s unlimited wants and our limited resources means choices must be made to decide how to allocate scarce resources.
In a free market, no shortage of any commodity ever exists. The quantity of a commodity supplied may be temporarily out of balance with the quantity of that commodity demanded. In a free market, the price will adjust to bring quantity supplied back into balance with quantity demanded. However, those free market price adjustments can be painful. Sometimes they are painful for consumers. Other times, producers endure the pain.
Intervention carries risks
Surging prices associated with perceived shortages often bring forth a hue and cry from consumers for “somebody” to do “something” to reduce prices.
Politicians listen. Many states have laws against price gouging in times of disaster. Such laws may ease the short-term consumer pain. But if left in place too long, they may complicate the market's efforts to find a price that will balance the new supply situation with the new demand situation.
Many economists agree that price ceilings, or controls, are almost always a bad idea. That is, problems caused by an economic shortage are usually more numerous, complicated and troublesome than the problem a price ceiling is intended to try to correct.
Push for efficiency brings bottlenecks
Decades of production and business managers practicing “just-in-time” delivery helped set the stage for the current crunch. A supply-chain disruption, no matter what the cause, makes products scarcer for consumers. Prices respond.
From another angle, as “just-in-time” delivery gained traction, the market punished managers who chose to maintain inventory cushions. Inventories tie up capital, must be stored and routinely rotated. Those factors cost money, which means businesses that maintained inventories had higher costs. Competitors undercut them on price, forcing many out of business.
Businesses face no-win situation
Businesses often face pressure to maintain low, or sticky, prices regardless of the situation. Trying to raise prices may trigger a public outcry. Reputation matters. Some may argue that in times of increased scarcity, any business that wants to still be in business when the situation is over shouldn’t raise prices, or raise them very much — because when conditions improve, no one will want to be loyal to the business that sold them products for double, or more, the usual price.
On the other hand, empty shelves can erode customer satisfaction and reduce loyalty. So it’s in a business’s best interest to avoid stock-outs.
The consistency of a low selling price in conjunction with rising demand and decreased supply will result in a shortage.
Erring on the side of caution for statutory or social reasons, some businesses may try to hold prices artificially low. That approach can backfire. Surging prices can be the normal workings of competitive markets and can be beneficial during times of increased scarcity. They can help allocate goods and services to buyers who want them the most, or are most able to pay for them.
Hoarding worsens problems
On the demand side, efforts to keep prices artificially low and chatter about tight supplies can encourage overbuying. People who get to the store first benefit in that scenario. Have you heard this joke — On March 11, 2070, I will open the last package of toilet paper my parents bought in 2020.
Efforts to keep the price of meat below the market-clearing level might tempt consumers to buy as much as they can to pack their freezers — just in case. If, on the other hand, prices shoot up, consumers may become a bit more selective. They may buy less, buy different cuts or brands, or buy lower-priced products. That is the market adjusting.
Supply-side arguments also exist. Some are fairly short-run. For example, the quantity of red meat in cold storage at the end of November 2021 was at the lowest level for November since 2010. This was the case, even though 2021 red meat production was 13% higher than in 2010. Less meat in cold storage reflects a desire for sellers to cash in on high meat prices.
Longer-run supply-side arguments also exist. Cattle producers respond to profit, not prices. Prices must rise by enough to offset any hikes in production costs. If prices are strong and producers are making nice profit, they want to expand. They retain more heifers for replacements. Fewer heifers go to the feeder cattle market. Those actions actually push prices higher in the short run. This amplifies the expansion signal, high prices fueling more profits brings more expansion. Eventually, those heifers become cows, and calf crops increase in size. That's how the expansion phase of the cattle cycle works.
Feeder cattle hold good value
A quote in USDA’s National Feeder & Stocker Cattle Summary report for the week ending Dec. 18 went like this: “Good demand remains for most weights of feeder cattle, and the best demand remains on yearling cattle that will finish this spring. Those types of cattle are getting harder to find, and they must be heavier weights to meet that requirement of finishing before mid-May.” Kudos to USDA Market News for not calling the situation a yearling shortage.
Supplies of yearling cattle typically tighten seasonally at this time of year. Roughly three-quarters of the annual U.S. calf crop is born between Jan. 1 and June 30. In Iowa, it’s closer to 90%.
The overall supply of cattle is also tightening. The U.S. beef cow inventory peaked on Jan. 1, 2019, with the 2018 calf crop the largest of the current cattle inventory cycle. Estimated feeder supplies declined from the 2019 peak to 2020, but dipped only slightly in 2021. Herd contraction since 2019 has reduced replacement heifer retention and added to feeder cattle supplies, despite declining calf crops. However, as 2022 proceeds, smaller calf crops will result in more pronounced decreases in feeder cattle supplies.
After accounting for these biological constraints, the yearling supply — or probably more appropriately termed, availability — is a function of price. Of the 14,965 receipts of feeder cattle in the Iowa Weekly Cattle Auction Summary report for the week ending Dec. 18, 298 head, or 2%, weighed over 900 pounds. Only 106 head, or less than 1% of the total receipts, weighed over 1,000 pounds.
January 2021 CME feeder cattle futures were about 6% higher at the end of December than they were in early October. That’s a respectable three-month return. One can imagine a situation where producers had no intention of selling those heavyweight feeders during December. However, with corn prices swelling and the yearling market making offers they could not refuse, they sold at the next auction.
Let's feed them a few more days
In the slaughter cattle section of the same Iowa Weekly Cattle Auction Summary report, 162 head of the total 1,824 slaughter cattle receipts were denoted as “return to feed.” The return to feed designation is a comment market reporters use when a sale lot at a slaughter cattle auction is knowingly returning to a feedlot for additional feeding. Weights on these de facto feeder cattle ranged from 782 pounds to 1,390 pounds, with a weighted average of 1,152 pounds. Most of those are optimal weights to hit a seasonally and cyclically higher spring 2022 market.
In both cases, these yearlings may not have been “part” of the available inventory of yearling cattle that will finish this spring, because they may not have been sold, or went directly to slaughter under different market conditions. However, they did become part of the “supply” when the “demand” fostered the right price.