Tag: Inventories

‘Farm-gate’ milk prices (the price paid to farmers) have been rising in the UK. In July they reached a record high of 31.4p per litre (ppl). This was 5.1ppl higher than in July 2012. There were further price rises this month (October). Sainsbury’s increased the price it pays farmers by nearly 2ppl to 34.15ppl and Arla Foods by 1.5ppl to 33.13ppl. Muller Wiseman is set to raise the price it pays to 32.5p per litre.

And yet many farmers are struggling to make a profit from milk production, claiming that their costs have risen faster than the prices they receive. Feed costs, for example, have risen by 2.12ppl. On average, farmers would need over 38p per litre just to cover their average variable costs. What is more, exceptional weather has reduced yields per cow by some 7%.

Meanwhile, in the USA, supply has risen by some 1.3% compared with a year ago. But despite this, the prices of dairy products are rising, thanks to strong demand. Cheese and butter prices, in particular, are rising rapidly, partly because of high demand from overseas. Demand for imported dairy products is particularly high in China, where supply has fallen by some 6% in the past couple of months.

The problem for dairy farmers in the UK is partly one of the power balance in the industry. Farmers have little or no market power. Supermarkets, however, have considerable market power. As large oligopsonistic buyers, they can put downward pressure on the prices paid to their suppliers. These are mainly large processing firms, such as Robert Wiseman Dairies, Arla Foods and Dairy Crest. They, in turn, can use their market power to keep down the price they pay to farmers.

Articles

Dairy farmers renew protests over milk prices Farmers Weekly, Philip Case (5/9/13)
Dairy farmers ‘lost more than 1p/litre last year’ Farmers Weekly, Philip Case (2/10/13)
South West farming businesses and producers still making a loss on milk South West Business (3/10/13)
Q&A: Milk prices row and how the system works BBC News (23/7/12) (note date of this)
Positive Dairy Trend: Rising Milk Production and Strong Demand The Farmer’s Exchange, Lee Mielke (27/9/13)
Chinese supply crisis to delay dairy price adjustment Rabobank (25/9/13)
China milk ‘crisis’ fuels world dairy price rise Agrimoney (1/10/13)

Data

UK milk prices and composition of milk ONS
Combined IFCN world milk price indicator IFCN

Questions

  1. Give some examples of (a) variable costs and (b) fixed costs in milk production.
  2. Why may farmers continue in dairy production, at least for a time, even if they are not covering their average variable costs?
  3. What factors determine (a) the price of milk paid to farmers; (b) the retail price in supermarkets?
  4. Explain how dairy futures markets work.
  5. Could the milk processors use their market power in the interests of farmers? Is it in the interests of milk processors to do so?
  6. Why is there a Chinese “dairy supply crisis”? What is its impact on the rest of the world? What is the relevance of the price elasticity of demand for dairy products in China to this impact?

The second estimate of UK output for Q1 2010 from the Office for National Statistics reports that the economy grew by 0.3%. The first estimate, based on limited data, put growth in Q1 at 0.2%. But, it appears that more recently available data picked up evidence of stronger growth in the latter stages of the quarter, particularly in the production industries, such as manufacturing, as well as in capital spending by firms.

When analysed in terms of the composition of demand for our firms’ goods and services, there has been something of a rebound in investment expenditure. This follows a marked collapse during 2008 and the first half of 2009. In 2010 Q1 investment volumes increased by 4.2% on the back of a 2.4% rise in the last quarter of 2009.

This rebound in the investment figures across the last two quarters has partly been driven by firms running down their stockpiles of finished goods at a considerably slower rate. When firms build up their stocks of inventories for sales in future periods they are deemed to be engaging in investment. When firms then ‘tap into’ these inventories, as they have been since Q4 2008, they are disinvesting. It is now the case that the pace of disinvestment through running down inventories is slowing. This reflects a pick up in the demand for firms’ goods and services and, hopefully, an expectation of stronger future demand.

More encouragingly, the rebound in investment volumes in Q1 also reflected an increase in gross fixed capital formation, i.e. an increase in the purchase of non-financial fixed assets used in production, such as machinery. Gross fixed capital formation increased in Q1 by 1.5%. This was the first quarter since Q2 2008 in which there has been an increase in the volume of capital purchases by firms. Again, this is likely to reflect increased optimism about future demand since these assets are purchased to do one thing – to produce goods and services!

The improvement in the investment numbers is such that the volume of investment in Q1 2010 was 0.6% higher than it was in Q1 2009. This is largely the impact of a slower rate of disinvestment by firms through running down inventories since despite the rise in gross capital formation in Q1 2010 it still came in 5.7% lower than in Q1 2009. Nonetheless, it will be interesting to see whether the recent improvement in the UK’s investment numbers is maintained as we go forward.

Of particular concern is whether the volume of capital purchases can continue to grow. Can these purchases help to both boost growth now and our economy’s potential output in the medium term? Some of the key issues in determining the answer to this are likely to include: (i) the extent to which aggregate demand grows; (ii) the impact of fiscal consolidation measures on both firms and consumers; (iii) sentiment (confidence) across firms – especially of their own medium-term prospects; and (iv) the ability of firms to access credit from financial institutions. One can undoubtedly add many other issues to this list. One thing is for sure, these are very uncertain times indeed!

Articles

The economy: GDP growth revised up The Times, Grainne Gilmore (26/5/10)
Manufacturing pushes up economic growth The Independent, Sarah Arnott (26/5/10)
UK economic growth revised up to 0.3% BBC News (25/5/10) )
Economy tracker: GDP BBC News (25/5/10)
Boost for UK as GDP growth revised up Telegraph, Edmund Conway (25/5/10)
UK GDP growth revised upwards to 0.3% Financial Times, Daniel Pimlott (25/5/10)
UK first-quarter GDP revised higher Wall Street Journal, Natasha Brereton (25/5/10)

Data

Latest on GDP growth Office for National Statistics (25/5/10)
UK output, income and expenditure, Statistical Bulletin, 1st Quarter 2010 Office for National Statistics (25/5/10)
UK Output, Income and Expenditure, Time Series Data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission

Questions

  1. Why do the National Accounts record a positive change in inventories as investment and a negative change in inventories as disinvestment?
  2. What factors might explain the running down of inventories across firms in the UK since Q4 2008? Why didn’t this start in Q2 2008 when the UK economy went into recession?
  3. In Q1 2010 the running down of inventories was worth, at 2005 prices, some £1.347 billion. This was considerably less than the £4.883 billion in Q3 2009 and the £2.596 billion in Q4 2009 (again at 2005 prices). Why might the pace of disinvestment be slowing?
  4. Of what importance do you think, firstly, the change in inventories and, secondly, gross capital fixed formation are for an economy’s potential output?
  5. What arguments do you think there are for distinguishing between different types of investment goods and services when considering our future economic growth?