Climate Change and Elasticity

 Elasticity---the responsiveness of production and consumption to price---is important to keep in mind when thinking about potential climate change impacts on agriculture.  Sadly, much of the profession doing empirical work on potential climate impacts seems to ignore this part of the equation.  I'm thinking particularly of this paper and this paper, both of which have other issues (see here and here).

On a global scale, supply and demand of staple commodities are highly inelastic.  Demand is inelastic mainly because commodity expenditures comprise a small share of the price of most consumption goods. Supply is inelastic because there's only so many places where it makes sense to grow certain crops. As a result, commodity prices can be very sensitive to shifts in supply or demand.  If climate change causes a big inward shift in supply, it could cause a huge loss in consumer surplus.  But if climate change were to cause a big outward shift in supply, the welfare change would be modest.

This is a key reason why uncertainty with climate change matters: the potential downside is so much bigger than the potential upside.

Sadly, what we often see from economists are references to the tiny share of agriculture in world GDP Thomas Schelling is a famous example (he makes good points about the bargaining problem). But GDP is no welfare measure.  And the difference between GDP and welfare is going to be large, mainly because it doesn't count a huge consumer surplus.

Elasticity and Climate Change
Now, it is true that a lot of the loss in consumer surplus will be offset by gains to producer surplus.  The U.S., with its large land base, excellent soils and climate, produces and exports more than anyone else in the world.  A doomsday scenario for food production doesn't look so bad for us--we'd be the ones gaining a lot of that producer surplus.

But in other places, particularly in certain developing countries with large urban populations, demand is not quite as inelastic. This is because the urban poor spend a large share of their income on staple food commodities, and when prices change a lot, it changes their real incomes a lot, and they spend less. So a lot of the loss in consumer surplus is likely to land on the people who most value that surplus---a dollar of surplus to a typical person in India is worth a lot more than it is to us.

A contemporary case in point: As I recall, Egypt imports about half its wheat and about half the people live on $2/day or less.  Today's high wheat prices must be doing a lot of damage to their real incomes.  And they are letting the world know about it.

Update I'm not the only one thinking about commodity elasticities.  I think I posted mine first. But the other guy always puts things much better than I do...

Update 2:  Krugman made this issue a headline column.  He's basically outlined my current research agenda. 

Comments

  1. This comment has been removed by a blog administrator.

    ReplyDelete
  2. Michael,

    I like your six graphs illustrating the point about GDP and consumer surplus.

    However, it is still easy for most U.S. citizens to dismiss the importance of climate change for agriculture on the basis that:

    (1) only a small share of the cost of their food goes to commodities such as corn and wheat (much of the cost is in the packaging, advertising, transport, wholesale, retail)

    (2) food cost is only a small share of the average American's expenditure.

    Indeed, food is subsidized and the fast food restaurants will happily sell you an awful lot of calories (in the form of a value menu burger) for $1.

    Now both (1) and (2) are NOT true, of course, for most of the people in most developing countries. That is where the big concern lies, IMO.

    Jeff Reimer

    ReplyDelete
  3. I guess you already made some of the points that I am making in your post -- I failed to read all the way to the very end, where you talk about Egypt.

    Anyway, my basic point remains: the share that ag. has of GDP is not necessarily an unfair way to assess the importance of climate change on ag. for a country's citizens. It proxies for the stage of development that a country is in, and thus how rich its citizens are likely to be.

    ReplyDelete
  4. Jeff,

    I agree with you completely here. The inelasticity of demand comes precisely from the fact that commodity prices matter so little for us.

    But that inelasticity is also what helps to make prices so volatile, which is what's so bad for the poorest one or two billion in the world.

    It's a simple point, but I don't think it can be made often enough.

    ReplyDelete

Post a Comment

Popular posts from this blog

Renewable energy not as costly as some think

Answering Matthew Kahn's questions about climate adaptation

Paul Krugman on Food Economics