The paradox of price and profit, or why high prices don't always translate into high profits

As I noted in a couple of posts about kūmara last week (see here and here), recent weather events have reduced the supply of many vegetables, raising their prices. In the minds of most people, high prices equate to higher profits for sellers (more on that point in my next post as well). However, that is not necessarily the case. As the New Zealand Herald reported yesterday:

This will be one of the worst years for growers in Aotearoa despite rising prices at the supermarket, says an industry chief executive...

Leaderbrands chief executive Richard Burke said fresh produce prices are unlikely to go down at the supermarket as severe weather across the North Island means growers’ supply has been hard hit...

Burke said conditions are unprecedented for growers across the country: “People think when there are high prices, growers are making a lot of money. But frankly, this will be one of the worst years we’re facing, no question.”

“We’re certainly not making more money under these high prices,” Burke said.

“I think a lot of growers will be in the same boat. I would think growers are feeling rather tired and have worked pretty hard, but it’s not falling to their bottom line.”

It seems a little paradoxical, so how can it be that high prices do not lead to high profits for farmers? Consider the market for broccoli, as shown in the diagram below. Before the storm, the market was operating at equilibrium (where the demand curve D0 meets the supply curve S0), with a price of P0, and Q0 tonnes of broccoli were traded. The diagram also shows the producer surplus, which can be thought of as the collective profits of the sellers (if we ignore fixed costs). Producer surplus is the difference between the price that sellers receive for the good, and the sellers' costs. Since the supply curve shows the sellers' marginal costs of production (MC), the producer surplus is the area below the price, above the supply curve (or marginal cost curve), and to the left of the quantity traded. That is the area of the triangle P0BC.

Now consider what happened as a result of the bad weather. The supply of broccoli decreased from S0 to S1. The equilibrium price increases from P0 to P1, and the quantity of broccoli traded decreases from Q0 to Q1. What happens to farmer profits? The new producer surplus is the area P1DE, which is clearly smaller than the original producer surplus of P0BC. [*] Producer surplus decreases. Farmers are less profitable, even though they are able to sell broccoli at a higher price.

This makes sense if you think about it without even considering the market model above. Farmers are receiving a higher price for broccoli, but they have less broccoli to sell. On top of that, their costs of producing broccoli have increased. What we should take away from that is that high prices don't always translate into higher profits for sellers. How those high prices came about it an important consideration.

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[*] You may doubt that the triangle P1DE is smaller than P0BC. The difference might not be obvious by eyeballing the diagram. However, P1DE is most assuredly smaller. The area of a triangle is half its base multiplied by its height. Both triangles have the same height (the distance from C to P0 is the same as the distance from E to P1). The triangle P1DE has a base that is equal to Q1, while P0BC has a base that is equal to Q0. So, the triangle P1DE must be smaller than P0BC.