Saturday 24 September 2022

Is the Australian egg market demonstrating a cobweb pattern?

Last month in The Conversation, Flavio Macau (Edith Cowan University) wrote an interesting article about the egg market in Australia:

Australia is experiencing a national egg shortage. Prices are rising and supermarket stocks are patchy. Some cafes are reportedly serving breakfast with one egg instead of two. Supermarket giant Coles has reverted to COVID-19 conditions with a two-carton limit.

It's worth thinking about what has gotten Australia into this situation. Macau notes that:

Between 2012 and 2017, free-range eggs’ share of the market grew about 10 percentage points, to about 48%. Growth in the past five years has been half that.

But with more rapid growth predicted, and the promise of higher profits, many egg farmers invested heavily in increasing free-range production. In New South Wales, for example, total flock size peaked in 2017-18.

Like many agricultural industries where farmers respond to price signals and predictions, this led to overproduction, leading to lower prices and profits. This in turn led to a 10% drop in egg production the next year.

Now, consider the market for free range eggs, as shown in the diagram below. Demand increased substantially from 2012 to 2018, which is shown by the increase in demand from D0 to D1 (from Time 0 to Time 1). That pushed the price of eggs up from P0 to P1, and the quantity of eggs produced increased from Q0 to Q1 in response (the farmers increased production). Now, with the high price P1, farmers want to continue producing more eggs (Q2 for Time 2), but the demand has decreased back to where it was before (D2). [*] The quantity Q1 is now too many eggs, and to sell that many eggs, the farmers have to accept a lower price (P2). So, now they respond to the low price by cutting production to Q3 (for Time 3). But that level of egg production is too low, and the farmers are able to sell those eggs for the high price P3. Then, with the price high at P3, the farmers decide to increase production to Q4. And so on. Notice that this market is forming a cobweb pattern (following the red lines).


Now, is what we just described happening in the Australian egg market? Is there a cobweb model here? The cobweb model, as I have described before, relies on a key assumption: that the market has a significant production lag. Producers make their decisions about how much to produce today, but don't receive that production until some time in the future. This is a common feature of agricultural markets, but is it a feature of egg production? Chickens lay eggs every day (approximately), so when you consider it at that level, there is no production lag. Certainly, farmers don't have to wait long for eggs. However, the relevant production lag here isn't the production of eggs by chickens, it is how long it takes the farmers to respond to a change in price. If price falls, farmers may want to reduce the number of chickens they have, but that takes time (albeit, not a lot of time, since they can round up chickens and send them to a meat processor). If price rises though, farmers may want to increase the number of chickens they have, and that takes time, since they have to raise those chickens until they are ready to lay eggs. So, maybe there is half a production lag here - a lag in increasing production, but little lag when it comes to reducing production. So, this is not quite the cobweb model that I describe in my ECONS101 class (and as described for the diagram above). It does share some of the features of the cobweb, but only when prices are too low - it takes farmers more time to adjust to low prices than to adjust to high prices.

Australia finds itself in the uncomfortable position of having to wait for farmers to raise enough chickens so that egg production can increase. Once that happens, the market will adjust back to equilibrium (with a higher egg price).

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[*] Astute readers will note that the article only says that demand growth has fallen, rather than demand per se. However, if farmers are expecting high demand growth, and demand is less than farmers expected, that is similar to a decrease in demand. Not exactly, but close enough for our purposes.

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