Coase and Hog Cycles

by David Williamson

If you read this blog, then you're probably familiar with Ronald Coase's work on the importance of transaction costs. But did you know that Coase devoted a substantial portion of his early career to criticizing the Cobweb Model? He actually wrote 4 separate articles on the subject between 1935 and 1940, but not one makes Dylan Matthew's list of Coase's top-five papers. This work is actually really fascinating in the context of economic intellectual history, so here is a quick summary!  

The 1932 UK Reorganization Commission for Pigs and Pig Products Report

It all started when the UK Reorganization Commission for Pigs and Pig Products claimed in a 1932 report that government intervention was needed to stabilize prices in the hog industry. The Commission found that hog prices followed a 4-year cycle: two years rising and two years falling. The Commission explained this cyclical behavior using the Cobweb Model. In this model, products take time to produce. So, to know how much to produce, firms have to guess what the price will be when their product is ready to bring to the market. If producers are systematically mistaken about what prices will be, this could lead to predictable cycles in product spot prices.

The Cobweb Model

How forecasting errors can lead to cycles in product prices is illustrated in the figure below. Suppose we begin time at period 1 and hog producers bring Q1 to the market to sell. Supply is essentially fixed this period because producers can't produce more hogs on the spot, so the price that prevails on the market will be P1. Since this price exceeds the marginal cost of production (represented by S), the individual producers wish they had produced more. Now, when the producers go back home to produce more hogs, they have to guess that the price will be when their hogs are ready to sell. Suppose it will take 2 years to produce more hogs. The UK Reorganization Commission argued that hog producers will assume the price of hogs next period will be the same as it was this period (in other words that producers had "static" expectations about price). That means, in this context, hog producers think the price of hogs in 2 years will still be P1. So each producer will individually increase production accordingly. However, when the producers return to the market in 2 years, they will find that everyone else increased production too and that quantity supplied is now Q2. As a result, the price plummets to P2 and the producers actually lose money. Not learning their lesson, the hog producers will again go home and assume that the price next period will be P2 and collectively cut back their production to Q3. Hopefully you see where this is going, even if the hog producers don't. The price will go up again in 2 years and then down again in 2 more. Thus, we have a 4-year cycle in hog prices. How long will this cycle continue? That depends on the elasticities of supply and demand. If demand is less elastic than supply, as was believed to be the case in the hog market, then the price swings will continue forever and only get bigger as time goes on.

Source: Wikipedia

Coase Takes the Model to the Data

The Cobweb Model is really clever, but does it actually capture the reality of the hog market? Coase and his co-author Ronald Fowler tried to answer that question by evaluating the model's assumptions. First, are hog producer expectations truly static? Expectations cannot be observed directly, but Coase and Fowler (1935) used market prices to try and infer whether producer expectations were static. It didn't seem like they were. Second, does it really take 2 years for hog producers to respond to higher prices? Coase and Fowler (1935) spend a lot time discussing how hogs are actually produced. They found that the average age of a hog at slaughter is eight months and that the period of gestation is four months. So a producer could respond to unexpectedly higher hog prices in 12 months (possibly even sooner since there were short-run changes producers could also make to increase production). So why does it take 24 months for prices to complete their descent? Even if we assumed producers have static expectations, shouldn't we expect the hog cycle to be 2 years instead of 4?  

This evidence is hard to square with the Cobweb Model employed by Reorganization Commission, but Coase's critics were not convinced. After all, if it wasn't forecasting errors that were driving the Hog Cycle, then what was? "They have, in effect, tried to overthrow the existing explanation without putting anything in its place" wrote Cohen and Barker (1935). Coase and Fowler (1937) attempted to provide an explanation, but this question would continue to be debated for decades.

The Next Chapter

Ultimately, John Muth (1961) proposed a model that assumed producers did not have systematically biased expectations about future prices (in other words that they had "rational" expectations). Muth argued this model yielded implications that were more consistent with the empirical results found by Coase and others. For example, rational expectations models generated cycles that lasted longer than models that assumed static or adaptive expectations. So a 4-year hog cycle no longer seemed as much of  a mystery. I'm not sure what happened to rational expectations after that. I hear they use it in Macro a bit.  Anyways, if you are interested in a more detailed summary of Coase's work on the Hog Cycle, then check out Evans and Guesnerie (2016). I found this article on Google while I was preparing this post and it looks very good.

References

Evans, George W., and Roger Guesnerie. "Revisiting Coase on anticipations and the cobweb model." The Elgar Companion to Ronald H. Coase (2016): 51.

Coase, Ronald H., and Ronald F. Fowler. "Bacon production and the pig-cycle in Great Britain." Economica 2, no. 6 (1935): 142-167.

Coase, Ronald H., and Ronald F. Fowler. "The pig-cycle in Great Britain: an explanation." Economica 4, no. 13 (1937): 55-82.

Cohen, Ruth, and J. D. Barker. "The pig cycle: a reply." Economica 2, no. 8 (1935): 408-422

Muth, John F. "Rational expectations and the theory of price movements."Econometrica: Journal of the Econometric Society (1961): 315-335.

Mandated GMO Labels: A Regressive Tax

by Levi Russell

The predictable effects of mandatory GMO labeling will be felt very soon in Vermont and those with low incomes will be especially hard-hit. Supermarkets in the state will lose some 3,000 products from their shelves. The video on this news story is telling: people don't seem to know much about GMOs and don't really think about the negative effects of mandatory labeling. Anti-GMO organizations such as Greenpeace have been accused of running a fear campaign that isn't supported by scientific evidence. There's no evidence that GMOs are harmful to people, but a law requiring them to be labeled very likely will be.

The federal law passed in the Senate will require companies to use QR codes or dedicated websites to provide information about the presence of genetically modified organisms in their food. The compliance costs associated with this law include the addition of the QR code or website URL to the packaging, the development of the databases with the required information, and the maintenance of this database as farming practices and ingredients change. The latter two will likely be far higher than the former and will affect food prices for the foreseeable future.

Here are some of the potential indirect effects:

1) Less consumer choice - The article linked above shows that this is already becoming a reality. I suspect those 3,000 products will come back to shelves eventually, but the development of new products is now more costly due to the necessity of adding information to GMO databases.

2) Higher prices - Additional costs to food companies will effectively shift the food supply curve to the left and raise prices.

3) Less innovation - Though "very small" food companies are exempted from the rule, many startups are created with the goal of becoming mass-market products (If you don't believe me, just watch an episode of "Shark Tank."). This requirement will be another cobweb of red tape these companies have to get through to get on consumer shelves.

Maybe all these costs are worth it. Given the lack of scientific evidence of harm and the fact that humans have been modifying the genetics of food in a far more haphazard way for a very, very long time, I have my doubts. The reality is that the costs mentioned above will fall disproportionately on those with the lowest incomes. Those with moderate to high incomes will be able to pay more for the food they really want, but for those who spend a substantial portion of their income on food already will find it harder to make other ends meet.

Legal and Economic Implications of Farm Data

by Ashley Ellixson

Discussions of farm data are a hot topic not only in today’s agricultural industry but also across the legal field.  I recently authored an article that describes the legal and economic concerns surrounding data ownership, privacy rights, and possible recourse in event of intentional data breach.  The publication aims to answer the questions around “who owns farm data?”, “what happens when farm data is misappropriated?” and “what can I do to protect my farm’s data?”  These questions and many more are swirling around industry, legislatures, and farm organizations.  

Until the law defines farm data or a court speaks to the protections of such data, experts in the field can only suggest best management practices (both at the farm-level and the legal liability level). From the farm perspective, not only the law but the relative value of farm data will direct the optimal choice for damages, if any. Damages may be realized as loss of local bargaining power or a direct cost to the farmer; however, only time will tell. This collaborative effort between Kansas State University and University of Maryland can be found on the AgManager.info website.  

Ashley Ellixson, J.D., LL.M. 

Guest Contributor

@Legally_Ashley

E-mail

Farmer Hayek at the 2016 Southern Ag Economics Association Meetings

Four of us will either be presenting at the SAEA meetings next week or are authors on papers and posters. Here's a list of titles with links to abstracts and full papers!

Levi Russell

Price Impacts of Brahman Influence in South Texas

Profitability of Beef Cattle Best Management Practices in South Texas


Michael Langemeier

The Challenges of Precision Agriculture: Is Big Data the Answer?

Economic Threshold for Dynamically Optimal Late Blight Management


Gregg Ibendahl

Kansas Farm Profitability Persistence: Do Top Farms Remain Top Farms? (also with Terry Griffin)


Terry Griffin

Defining the Barriers to Telematics for Precision Agriculture: Connectivity Supply and Demand

Value of Internet Connectivity Uptime for Multiple Vehicles Using Automated Section Control

Applying Data Envelopment Analysis Methodology to Site-Specific Precision Agriculture Data

Farmers' willingness to pay for farmland based on machinery and precision technology adoption

I, Pencil

Leonard Read's famous story "I, Pencil" is a short tale that reminds us of the wonders of the market that we observe all around us every day. We may take it for granted, but even a device as simple as a #2 pencil requires a massive effort on the part of economic actors.

The people who make the eventual production of a pencil possible are specialized in their own tasks and may have no idea what the eventual product of their labor will be. No one person plans the production of pencils, yet they sit on shelves around the world, ready for purchase and use. Below is a video version of Read's essay that I think readers might enjoy.

Potpourri

Jayson Lusk added some interesting questions to the January 2015 Food Demand Survey. The responses are pure gold.

Elise Hilton discusses new technology for reducing the amount of trash that ends up in landfills. Markets generate conservation behavior when the benefit of reusing or recycling a given resource is greater than the cost. Entrepreneurs are agents of change who create these opportunities.

The Cato Institute Blog has a brief roundup of posts around the blogosphere regarding the "common sense" of a carbon tax.

Jeffrey Dorfman at UGA has some suggestions for budget cuts for the new bicameral Republican majority in congress.

Brent Gloy and David Widmar of Purdue discuss 2015 economic issues related to producers and ag bankers.

Don Boudreaux explains why supposed generous behavior by established firms regarding the minimum wage is likely to limit competition.

Matthew Turner of Brown University discusses the economics of land use regulations in an article at PERC.

Bob Murphy's insightful analysis of the Fed's role in recent oil price moves.

Don Boudreaux links to an interesting graph of world-wide incomes in 1820, 1970, and 2000. This graph shows that increases in income and in income equality can happen simultaneously.

Potpourri

An interesting article on Progressive Farmer about low-pressure tires and soil compaction.

Jayson Lusk has an interesting post on the basic facts (and some interesting intuition) about corporate and family farms.

An interesting post by Pete Boettke at George Mason U. on the political leanings of academic economists. Some of the loudest economic voices on the internet are staunchly anti-free-market. Paul Krugman is the most obvious example. Pete mentions a study by Dan Klein which suggests that most economists "lean left" although they do so to a much lesser degree than academics in other social science fields. I hope to conduct a similar study some day for agricultural economists.

The most recent Federal Open Market Committee minutes suggest that the Federal Reserve will not begin to raise interest rates until April or later. The Fed sees recent declines in oil costs as beneficial on net, but is concerned that inflation may not be high enough in the coming months. It's difficult to understand why someone would think that always-rising prices are good when they also believe that lower prices due to increased supply are bad.

Thomas DiBacco has an interesting piece on the one and only time the U.S. national debt was zero.

A recent entry in the Urban Dictionary is pretty hilarious considering the new criticism of the famous book on inequality by Thomas Piketty.