Commodity prices and food inflation

Timothy J. Richards and Geoffrey M. Pofahl focus on how high and volatile commodity prices impact food prices. Commodity prices increased between 2007 and 2008, with corn prices rising 51.9%, soybean prices 74.4%, wheat prices 104.5%, and milk prices by 41.4% in the year between July 2007 and July 2008. Consumer demand is represented by a random utility model in which consumers are assumed to make a discrete, hierarchical choice of one product from among all products sold at the retailers represented in sample, or some other product from another outlet. Each supplier is assumed to set its wholesale price in order to maximize the surplus over production costs for the particular brand or variety he or she sells, conditional on the retailer's response. The cereal-model results indicate that when input prices are rising, wholesalers are able to raise margins, taking advantage of retail buyers' expectations that prices should be rising in an inflationary environment.