AGEC 640 – Agricultural Policy Thursday, September 18th, 2014

Nutrition and Food Markets

Today: Imperfect information & food demand

Reading: Masters and Sanogo, 2002 in AJAE

Homework #2 on food choices due Thr., 9/25

What’s behind consumers’ price and income response?

Slide 2

Price of food

Quantity of food consumed

P1

P2

Q1 Q2 Consumers’ income

Quantity of food consumed

Q2

Q1

Y1 Y2

“demand curve” “Engel curve” (=income-consumption curve)

price elasticity of demand:%∆Q/ %∆P

income elasticity of demand:%∆Q/ %∆Y

…we need to think very carefully about what generates these curves!

To understand food demand,we’ll want to consider…

• consumers’ optimization (“Econ 101” effects)–preferences: indifference curves and welfare–price effects: demand curves and elasticity– income effects: Engel curves and elasticity

• really constrained optimization (Econ 102, 103…)–what else might be useful to understand food intake?–benefits are delayed, and often not observable

• credit/insurance constraints (poor can’t borrow to buy food)• “behavioral” effects (predictable violations of rationality)

–weak self-discipline (addiction, obesity, etc.)–distorted perceptions (anxiety, obsession, etc.)

• information asymmetries (role of 3rd party quality assurance)

Quantity of “b” goods

Optimization and consumer preferences

Qb

Quantity of “a”, all other goods

Qa

Initial observedpoint “O”

The points in this quadrant offer less

of both goods, soany optimizing

consumer would prefer “O” to them

The points in this quadrant offer more of both goods, soany optimizing consumer would prefer them to “O”

All combinations amongst which the consumer is indifferent must fall along a downward sloping line.

Quantity of “b” goods

Optimization and substitution possibilitiesThe “indifference curve”

Qb

Qa

Eventually, one becomes less willing to reduce all other things in exchange for more of “b”, so the indifference curve becomes flatter here

Eventually, one becomes less willing to reduce “b” in exchange for more of all other things, so the indifference curve becomes steeper here

There is an indifference curve, drawn smooth for simplicity.

Quantity of “a”, all other goods

Quantity of “b” goods

Constrained optimization:Indifference curves and the “expenditure line”

QbQb

Qa

higher indifference levels

lowerindiff.levels

Indifferencecurve throughinitial point

Exp. = PaQa + PbQbQa = Exp./Qa – (Pb/Pa)Qb

Slope of expenditure line = -Pb/Pa

Expenditurelevel at the

initial point

Quantity of “a”, all other goods

Quantityof “b” goods

Indifference level at the initial point

The new indifference level is lower

The new expenditure line is steeperslope = -Pb’/Pa

Constrained optimization:When the price of “b” rises, how do consumers adjust?

Slope of expenditure line = -Pb/Pa

Quantity of “a”, all other goods

the price of b has no effect on this point

higher prices induce substitution and reduce “real income”

Price effects The Demand Curve

Price

Quantity Consumed

When price changes, consumers move along their demand curve.Welfare is lower at higher prices(later, we’ll see this as “consumer surplus”)

When income rises, consumers’demand curve shifts (usually to the right,

as consumers buylarger quantitiesat each price)

Income effects The Demand Curve

Price

Quantity Consumed

Price Elasticity of Demand

Price($/lb)

Quantity Consumed(lbs/yr)

1.25

10

1.00

15

To measure the “steepness” of demand curves in a more useful way than with its slope, we use

+5

-.25

the elasticity of demand (ε):= percentage change in quantity for

a percentage change in price= %ΔQ / %ΔP = 5/10 / -.25/1.25= - .5 / -.2= - 2.5

Elasticity and expenditure: “Price-elastic” vs. “price-inelastic” demand

Price($/lb)

Quantity Consumed(lbs/yr)

“Elastic demand” : demand curve is relatively flat when price rises, expenditure (P×Q) falls | ε | > 1

“Inelastic demand” : demand curve is relatively steep when price rises,

expenditure (P×Q) rises | ε | < 1

“Unit-elastic demand” : demand curve is such that when price rises, expenditure (P×Q) stays constant: | ε | = 1

Income Effects on Food Consumption

Price($/lb)

Quantity Consumed(lbs/yr)

1.25

10

1.00

15

Remember that when income rises, consumers’demand curve shifts (usually to the right)

It’s helpful to draw a curve of consumption on income, for a given price

QuantityConsumed(lbs/yr/pers)

Income ($/yr/pers)0 250 500 1000 5000 10,000

200

500

700 Engel curve for food use only

Engel curve for all uses

Income Effects on Food ConsumptionA hypothetical “Engel” curve

QuantityConsumed(lbs/yr/pers)

Income ($/yr/pers)0 250 500 1000 5000 10,000

200

500

700

Income elasticity (e) :% change in Q / % change in Yvaries widely by income level, and by type of use

Income Elasticity of Demand

(see slide 31a)

Income ($/year)0 500 1000 1500 2000 2500 3000 3500

Qty.Consumed(kg/year)

10

20

30

Elasticity along the Engel Curve

noeffect

elas

tic o

r

“lu

xury

”

inelastic or “normal”

negative or “inferior”

Income elasticity (e=%ΔQ/ %ΔY) is closely linked to income level :income-elastic (“luxury”) goods: e > 1income-inelastic (“normal”) goods: 0 < e < 1negative-elasticity (“inferior”) goods: e < 0

“necessary”

Average income and price elasticities of demand in Indonesia (estimated in the 1970s)

“inela

stic”

“elas

tic”

“inela

stic”

“elas

tic”

Reminder: elasticity is %ΔQ/%ΔY (income) or %ΔQ/%ΔP (price).

An extreme case: can price elasticity ever go positive?Such “Giffen” goods have finally been documented, by Jensen & Miller (2007)

Effect of income growth among the poorest 30% in Brazil, 1974-75

Income elasticities by income group, rural Brazil, 1974-75

(“luxuries” for the poor)

(“inferior” for everyone)

Calorie intake by nutrient group and income levelin

com

e le

vel in

196

2 (lo

g sc

ale)

calories from each nutrient group (percent of total)

The poorest eat mainly carbohydrates; income growth permits an increase in fats and proteins

Macronutrient intake by U.S. children aged 6 to 11 years

1977-78 1989-91 1994-96,98Girls Energy (kcal) 1,806 1,832 1,825

Protein (g) 69.3 67.2 62.7Fat (g) 77.8 69.8 66.8

Carbohydrate (g) 211.9 241.6 250Carbohydrate (% kcal) 47.4 52.6 54.9

Boys Energy (kcal) 1,950 1,891 2,050Protein (g) 75.6 70.1 71.2

Fat (g) 84.7 72.7 75.1Carbohydrate (g) 226.2 245.5 279.6Carbohydrate (% kcal) 46.8 52 54.8

Source: Enns, Mickle and Goldman (2002), Table 5.

At high (U.S.-level) incomes, we’ve been switching back to more carbohydrates.

Now… what else might be usefulto understand food intake?

• Food is a public concern, but it is not a “public good”• Food demand generate subtle kinds of market failures • One reason is that its benefits are important but

often delayed and often not observable, so we have:– credit and insurance constraints (the poor can’t borrow) – “behavioral” effects (people are predictably irrational)

• weak self-discipline (addiction, obesity, etc.)• distorted perceptions (anxiety, obsession, etc.)

– asymmetric information (need quality assurance)• example of Masters and Sanogo (2002)

study of infant foods in Bamako, Mali

Source: Demographic and Health Survey, 1995/96

Age in Months

33302724211815129630

Std

. D

ev.

of

Re

fere

nce

Po

pu

latio

n1.0

.5

0.0

-.5

-1.0

-1.5

-2.0

-2.5

-3.0

Mean WHZ

Mean HAZ

Weight-for-height (WHZ) and height-for-age (HAZ) of children in Mali, relative to international norms

The most severe nutritional deficits occur in a relatively brief period

Child mortality is closely linkedto their weight-for-height

Source: Reprinted from Fawzi, W.W., M.G. Herrera, D.L. Spiegelman, A.E. Amin, P. Nestel, and K.A. Mohamed. 1997. “A Prospective Study of Malnutrition in Relation to Child Mortality in the Sudan.” The American Journal of Clinical Nutrition 65(4): 1062-9 .

Why are nutritional deficits so severebetween 4 and 24 months of age?

• exposure to disease– due to initial introduction of water and solids, or – perhaps also more mobility and contact with others;

• deficits in nutrient intake– due to differences between infant and family foods,– and failure to provide enough infant-quality foods.

Characteristics of infant foods• Infants need foods of higher nutrient density than

the family diet, from when they outgrow the nutrients in breastmilk to when they can digest enough of the family diet.

• High density is obtained fromhigh-cost ingredients (oilseeds or animal products), mixed with low-cost staples (cereal grains, etc.)

• but parents cannot observe an infant food’singredient ratios and density, even after consumption,because other factors affect growth

Economics of credence goods

Akerlof (1970) and others: If quality is unobservable, quantity will be…zero! optimizing people will not respond to price… except as remedied by trust in a

brand.==> sellers use advertising and high prices

as visible commitments to quality, so– buyers must pay a premium over

known costs, to buy guaranteed quality, – e.g. premiums paid for “brand-name” lawyers,

pharmacists, auto mechanics, etc.

Table 1. Infant foods for sale in Bamako, Mali (1999)Brand name Packaging Retail Prices (FCFA/unit)*

Mkt. Stores PharmacyCérélac (wheat) 400 g. can 1400 1500 1615Cérélac (wheat) 200 g. box 600 850Cérélac (rice) 400 g. can 1600Cérélac (wheat/Banana) 400 g. can 1750Cérélac (wheat +3 fruits) 400 g. can 2240Blédilac** (wheat) 250 g. can 1270Blédina** lactée fruits 250 g. box 1830Farinor** (maize/soy) 400 g. box 1690 1750

 Source: Masters and Sanogo, 2002.

MISOLA 500 g. bag 300UCODAL (e.g. Sinba) 200 g. bag 200

 

Akerlof (1970) saw an alternative remedy to lower the cost of credence goods: third-party certification – mandatory testing => complete coverage

examples: FDA, USDA limitations: tax-funded, incentive for fraud

– fee-for-service => self-sustaining, self-policingexamples: ISO, UL limitations: scale economies,

may not emerge spontaneously

Economics of credence goods(continued)

Benefits and Costs of Certification in Mali

1. benefits of certification–what is food-quality information really worth?–do some mothers value information more than others?

2. costs of certification–what are set-up and marginal costs?–what volume would be certified?

3. net gains from certification–do they justify the investment risks?–would the program be sustainable?

To detect what certification is worth, we need a experimental economics..

Vickrey (1961) and others: Preference-revealing auctions mimic real markets:

price is fixed by others; choice is to accept or decline

M&S experiment is aimed at very, very low-income people --avoids using money, so choice is among infant foods only;avoids calculations, so choice is easy and natural:

• give mothers a can of Cerelac• offer to swap for increasing quantities of substitute products• record whether they accept or decline each choice• give them one of their choices, selected at random

The design is not quite strategy-proof; respondents may hold out for slightly more of each substitute than in ideal auction.

Summary statistics for willingness-to-pay results WTP (FCFA per 400 g.)ave. s.d. min. max.

WTP by product 1. Cerelac 1500.00 (market price) 2. Certilac 1159.83 357.77 667 1500 3. Anonymous product 704.59 210.36 462 1500 4. Raw ingredients 119.14 35.07 75 150WTP for premium for 2 over 3: Certification 455.24 251.22 0 1038 for 3 over 4: Processing 585.45 213.97 312 1425

So certification has large benefits…but what would be its cost?

• 10 million FCFA/month for advertising• 1 m. FCFA/mo. per 50 tests/mo. for staffing• 0.6 m FCFA/mo. per 20 tests/mo. for transport• 3,520 FCFA/mo. per test for consumables• 1,000 x 400g. sold per test done

=> cost falls below ave. WTP at 30,000 bags/mo.=> cost falls below 100 FCFA at 215,000 /mo.

How much food would be certified?

• 50,000 children aged 6-24 months in Bamako• 100 g./day average consumption per child

=> 8 bags of 400 g. per month• low scenario: 39% use (now using Cerelac)• high scenario: 89% use (now using any food)

=> total potential is 155,000 – 350,000 bags/mo.

Would certification’s benefits exceed its costs?

• Two ways to estimate:(1) Each respondent has a different WTP

– Some respondents’ WTP below cost– Construct demand curves & optimal quantity– Find economic surplus

(2s) All respondents have identical WTP– Average WTP is way above cost– Full market size is certified– Find total benefits - costs

0

200

400

600

800

1000

1200

0 50 100 150 200 250 300 350 400

ThousandsQuantity Sold (400 g. bags/month)

Cert

ific

ation C

ost

(F

CF

A/4

00 g

. bag)

Demand-Case 1 Demand-Case 2 Cost of Cert.

ea

c

b

d g

f

Estimated certification demand and average-cost curves

Table 3. Consumer surplus and net benefit from certification 

Case 1 Case 2 Consumer surplus approachEquilibrium qty. certified (400 g. bags/mo.) 150,000 345,000Net economic surplus gain (FCFA/month) 51,543,984 134,029,438Net economic surplus gain (US$/year) 951,581 2,474,390Cost-benefit analysis approach Total estimated market size (400 g. bags/mo.) 154,746 353,138Net economic benefit/month (FCFA/month) 51,713,454 132,138,264Net economic surplus gain (US$/year) 954,710 2,439,476

OK, so quality information is needed…should testing be voluntary or mandatory?• Private solutions work if a “certifier” can

– force users to pay (that is, exclude free-riders), e.g.:• Underwriters’ Laboratories (sellers pay for label)• Consumer Reports, CarFax (buyers pay each time)

– and thereby capture enough revenue• to pay the cost of obtaining the information; while• maintaining a credible quality signal of their own!

• Often it’s cheaper to use the government:– “value capture” from consumers can occur through taxation (e.g.

USDA grades) or user fees (e.g. air traffic)– quality-destroying competition can be barred by mandatory

standards and licensing– but the “quality” being upheld may not be valued by consumers;

standards may be just an entry barrier to protect insiders

…Some conclusions• Food intake decisions involve

– not only observable attributes (taste, texture, color), – but also unobservable qualities and delayed effects.

• Food choices can be hard to understand using economics on observable prices and quantities only – so sometimes we need inferences and experiments– but much of the “irrationality” in food consumption

can be understood as constrained optimization– this allows us to plan public interventions that raise

welfare, even though food is not a public good.