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Rising Meat Prices Illustrate Economic Principles

Article-Rising Meat Prices Illustrate Economic Principles

The U.S. drought is forcing producers to liquidate, causing a sharp rise in beef prices.

Beef prices are rising so sharply that it's possible McDonald’s will be forced to remove its popular McDouble from the Dollar Menu. The item's high beef content makes the ratio of ingredient cost vs. price less favorable than for other menu items. Now, that's a national crisis.

Less facetiously, USDA's weighted average of all retail beef prices hit a new high of $5.12/lb. in December, up about 3.5% since August. Indications are that they have continued to rise since then. However, adjusted for general inflation, they remain in a band that has prevailed for 30 years and are still below any time from 1970 through 1983.

It also is an opportunity for economics teachers because the story of the beef price spike is chock-full of examples of economic principles at work.

Start with the simple principle that supply – a producer's willingness to sell different quantities of a product at different prices – depends on the marginal cost of production. Marginal cost is the increase in total cost from producing one more unit of the product.

News stories correctly note that beef is going up for two related reasons. A multiyear drought has been the scourge of some areas like Texas, which have many cow-calf operations, meaning many ranchers began to liquidate at least parts of their herds in the past year. Moreover, in the shorter term, the more widespread lack of rain over corn-soybean growing regions in 2012 has pushed up feed costs for cattle feeders.

The short-term response to forced herd liquidations such as this is a decline in meat prices because the sale of breeding animals increases the supply. But after that immediate effect, prices start to rise because fewer young cattle are on the way to feedlots, thus driving up costs.

That could happen at any time. In fact, it was already happening because the drought in ranching areas occurred before the drought in corn-growing states. So feedlots now face higher marginal costs, not only in the purchase of feeder cattle, but also in the feed needed to fatten them. As an introductory micro-econ class explains, they will keep on producing the same quantity as before only if the price rises.

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