CME: What's Happening with Hog Demand?

US - What is happening with hog demand? This past week’s data show that hog prices were roughly 35 per cent higher than one year ago on 6 per cent lower hog slaughter and 5.8 per cent lower pork production, write Steve Meyer and Len Steiner.
calendar icon 17 May 2010
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That relationship between the price change and quantity changes suggests a price flexibility of roughly –5.8 or a price elasticity of demand for hogs of –0.17. That implies a very inelastic demand curve — much as the demand we dealt with from 1995 though 2006.

The chart below shows the implied hog price flexibility on a quarterly basis for 1970 through Q1–2010. As you can see, the ‘70s, ‘80s and about half of the ‘90s provided a pretty solid basis for the rule of thumb that a 1 per cent change in hog supply would drive a 2 to 3 per cent change in hog price in the opposite direction. Since the flexibility is the inverse of the price elasticity, this meant that the demand for hog had a flexibility of –0.33 to –0.5, numbers that fit reasonably well with many of the elasticities estimated by various econometric model at that time.

But the world changed in the mid 1990s. First, hog demand became much more inelastic, meaning that given changes in output had much larger impacts on prices. To get close on price forecasts, one had to use flexibilities of –5 or –6, implying elasticities of –0.16 to –0.20. We know of no one who has conclusively determined why this change occurred but it coincides with the completion of the rationalization of excess slaughter capacity in the pork industry, implying that the sector had far less flexibility to handle extra hogs, thus exaggerating the impact of higher supplies on prices. The remaining large plants needed higher capacity utilization rates in order to drive unit costs lower. The need for sufficient supplies almost certainly drove slaughter firms to chase hogs when supplies were short, thus exaggerating price movements on high side as well.

The late 1990s brought a huge amount of variability in the price:quantity relationship as quarterly hog demand was apparently very, very erratic. In fact, from Q4-2003 through Q1-2010, over half of the implied flexibility observations did not even have the correct sign. They were positive instead of negative, indicating either higher prices and higher supplies or lower prices and lower supplies — something that cannot happen with a relatively stable demand curve for a normal good.

The past two years have brought us back to a bit of “normality” — at least from a historical perspective. While three quarterly observations have indeed been positive, six observations since mid-2007 have been between –1.1 and –3.7, with -2.37 the average of those six observations. But April data will almost surely show a larger price flexibility and the May data cited above say we might be back to the 1995- 2006 situation — hopefully without the huge amount of variability.

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