Marketing margins and the welfare analysis of food price shocks

Following the surge in world food prices of 2007-2008, there has been a revival of short-run household welfare analysis that seeks to understand whether food price increases are beneficial or detrimental for households. For a number of reasons, including lack of data in some instances, the short-run analytical approach has embedded an assumption of equal percentage price changes for consumers and producers. This assumption implies that food marketing costs change by the same percentage, because an x percent change in both farm prices and consumer prices implies that there must also be an x percent change in their difference. But this paper shows that most marketing costs are fixed, not proportional, and further that assuming proportional marketing costs leads to a bias towards finding negative impacts of higher food prices. The magnitude of the bias is shown to be greater than that from failing to incorporate supply and demand responses to price changes, and can be substantial relative to the effect estimated without incorporating the bias. In addition, the bias is not necessarily uniform across income classes; thus, failure to explicitly consider marketing margins has the potential to reverse the relative magnitudes of the impact on rich and poor.