As worried families rein in spending as the recession deepens, a growing fraction of Minnesota farmers have their own economic worry: What is the ‘income elasticity of demand’ for organic foods? Both production and consumption of organic products has grown markedly since the last recession. The sector may be facing a real test.
“Income elasticity of demand” is a simpler concept than it sounds. It refers to how people change their purchases of a given product as their income changes.
There are some things people buy less of as their income rises. Boxed macaroni and cheese, oatmeal, bowling and bus rides are purchases many forsake as their income grows and they can afford more expensive substitutes. Economists term items in this category “inferior goods,” though that is not meant as a judgment of their wholesomeness.
Items people buy more of as their income rises are more numerous. When people have more income to spend, they increase their purchases of many kinds of food, clothing, vehicles, household goods and recreation or entertainment.
The idea of “income elasticity” is not limited just to the direction of change, to whether consumption goes up or down as income rises. It also deals with how big a change is. If a household’s income goes up 10 percent, it may buy 5 percent more of some items but double its purchases of others.
Organic food products generally cost more than similar non-organic ones. Higher-income households do tend to spend more on organics than low-income ones, even though you may encounter people from all walks of life in the organic section of your food store. And purchases of organic products do tend to rise with income, although the degree to which they do varies from one product to another.
The premium can be substantial. A gallon of organic milk at the nearest food co-op costs about 40 percent more than a gallon of non-organic at my neighborhood food store. But increasing numbers of people have been willing to pay the difference, and the number of Minnesota farmers and the amount of farm output that is certified organic is growing.
Organic farmers have higher per-unit costs than non-organic producers. Thus, they also need to get a higher price for their output than the general market price for non-organic products. That difference can vary widely. A year ago, my brother-in-law at an organic dairy farm was getting about 1 1/2 times as much for his milk as my cousins were getting for their non-organic product.
Milk prices have been falling, down about 50 percent from the high point last year. Non-organic has dropped faster than organic, so that as of Jan. 30, the difference was 2 1/2 times.
(Before you quit your day job to start an organic farm, remember that organic corn and hay, needed to produce organic milk, also cost substantially more than the general kind. And the organic dairy producers fear that their prices also will tumble after a brief lag.)
Moreover, as in so many other areas of our economy, these producers feel they are in uncharted waters. The substantial growth of sales of organic foods over the past decade stemmed primarily from what economists call a “change in tastes and preferences.” More people have decided organic foods are healthier, and they are willing to pay for them.
But rising incomes and the perception for many households that their wealth was rising along with house values also helped. It is easier to spend a few more dollars for what you think are superior groceries when you just got a good raise, your last 401(k) statement showed a nice rise, and neither you nor your spouse are worried about getting laid off. But what happens now?
Some observers see a segmented market. There is a core of die-hard organic customers who would sacrifice nearly anything else before buying non-organic food. But other people see organic as preferable but not essential. Which group is larger and how much the swing buyers cut back are the $64,000 questions.
For producers, it is not just a question of passively waiting to see their fate. If demand for organic products wanes, they can choose to accept lower prices to maintain sales volume and market share. Or they can opt to maintain price and sacrifice market share. The decision is a hard one if you don’t have the data to forecast the alternative outcomes.
Many organic farmers sell through cooperatives and thus have some say in pricing strategies for the final product. But not all producers think alike. Some, especially those with higher production costs, are loath to accept any voluntary price declines. Others, including some veteran producers who look back on years of struggle to gain market share and break out of the status of a very narrow specialty market, are more willing to take short-term losses to maintain that hard-won share.
If you think about it, it isn’t much different than the historic tensions within OPEC between cut-price-to-maintain-share Saudi Arabia and keep-price-up-at-all-costs Nigeria and Venezuela. But it matters more in rural Minnesota.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.