What do fat steers and cargo freighters have in common right now? I’ll bet that one of my smarter microeconomics students would come up with the right answer. Both cattle and ships have very inelastic supply.
Producers cannot increase the quantity offered for sale very much when prices go up, at least in the short run. This is of more than academic interest because it is why families will pay more for meat in coming months.
Minnesotans who follow the news know that the prices of beef cattle are hitting historic highs. But even those who don’t follow the news soon will discover higher prices at the meat counter.
The record high prices apply to cattle ready for slaughter and the lighter animals going into feedlots. The highs are historic only if one does not adjust for inflation. Still, they are getting attention. Prices for slaughter cattle hit $1.08 per live pound this week and may go higher. The same steers would have brought 58 cents per pound in September 1998.
Fewer Minnesotans may know that ocean freighter shipping rates are hitting similar peaks. Rates for dry (non-oil tanker) vessels, which are largely set in London shipping brokers’ exchanges, have quadrupled in the last 12 months and have risen 50 percent in just the past few weeks.
A recent article in the Financial Times cited rates for large bulk carriers of $73,000 per day and noted that historically, the average daily rate for these ships generally was in the $6,000 to $25,000 range.
Such extreme price variations are rare for most goods. Producers of toilet paper, sweatsocks, hamburger buns and motor oil all tend to have excess production capacity. Factories run one or more shifts, but not at full blast. If the price of the products in question rises, the producer can add overtime or run an additional shift.
They can ratchet up raw material orders without much delay. This ability to respond quickly to higher prices means that we usually don’t see the price of goods like bread or underwear quadruple in a year.
Not every important product involves such flexible response, however. Ships and fat cattle involve long lags in production.
If someone orders a new freighter now it would be unusual to get it sooner than 18 to 24 months. Even if the ship is an exact copy of one already built, a shipyard has to order the steel, engines and other materials. Some highly mechanized yards can put a basic hull together in several months, but finishing the whole ship is time consuming.
Similarly, if cattle raisers decide to produce more cattle, it takes years before there is much output. Ranchers need to keep back young females that would otherwise be sold for slaughter. These heifers must be bred, which may take some months. The gestation period for cattle is about the same as for humans. Once born, the new calves take nearly two years to get up to market weight.
These long lags in ramping up production mean that there is nothing to keep prices from going sky high if the quantities that consumers want exceed existing production levels. That is what is happening to cattle and cargo freighters right now.
The beef situation is even more involved since high and low prices in cattle markets often induce a perverse reaction. The chain is as follows: When prices are low, as they were back in 1998, some producers get discouraged and sell out. Their breeding stock is dumped on an already saturated market. Even ranchers staying in the business tend to cull heavier and keep fewer replacement heifers. These actions increase supply and further depress prices.
Smaller herd numbers, however, reduce production and prices eventually rise. As they get higher, ranchers respond by culling less aggressively and by keeping back more replacements. This reduces slaughter numbers and accentuates the price spike. But it also ensures that output will once again outpace demand when the larger calf crops resulting from less culling and more replacements hit the market.
The result is an industry that perennially swoops from boom to bust in a cycle that repeats itself over a period of seven years or so. So if beef prices get high this winter, don’t worry. They will be dirt cheap again in just a few years.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.