Statement of

Dr. Ephraim Leibtag, Research Economist

Before the Committee on Education and Labor

July 9, 2008

Hearing on

The Rising Cost of Food and Its Impact on Federal Child Nutrition
Programs

Mr. Chairman and Members of the Committee, my name is Ephraim Leibtag
and I am an economist with the USDA's Economic Research Service
researching retail food prices and the dynamics of retail food markets.
I appreciate the opportunity to speak to you today about trends in U.S.
food prices.

In 2008, the Consumer Price Index (CPI) for all food is projected to
increase 4.5 to 5.5 percent, as retail prices reflect higher commodity
and energy costs. The main factors behind higher food commodity costs
include stronger global demand for food, increased U.S. agricultural
exports resulting from stronger demand, weather-related production
problems in some areas of the world, and the increased use of some food
commodities, such as corn, for bioenergy uses.

Food-at-home prices are forecast to increase 5.0 to 6.0 percent, while
food-away-from-home prices are forecast to increase 3.5 to 4.5 percent
in 2008. The all-food CPI increased 4.0 percent between 2006 and 2007,
the highest annual increase since 1990. Food-at-home prices, led by
eggs, dairy, and poultry prices, increased 4.2 percent, while
food-away-from-home prices rose 3.6 percent in 2007.

Because a full assessment of crop damage was not available at the time
of this forecast, this update does not explicitly account for
potentially higher corn and soybean prices due to crop damage from
recent flooding in the Midwest. Estimates of the impact of potential
supply disruptions on food prices will be included in this data series
once an assessment of the flood losses becomes available.

***Measuring Food Price Change***

To better understand recent trends, we need to know how food prices and
price changes are measured. Food prices are measured by the Federal
government through monthly collection of prices from a representative
group of food-stores and foodservice establishments. Items selected for
price measurement cover all consumer goods and services.

The Federal government has two basic measures of price change, both of
which compare prices in a base year to prices in a current year: The
Consumer Price Index (CPI), and the Producer Price Index (PPI). For
products purchased by consumers, the All-Items CPI is used to represent
average increases or decreases in prices paid for retail goods and
services. The All-Items CPI is composed of a number of sub indexes,
including the Food CPI.

There are separate food indexes reported for food-at-home, which
consists of food sold in retail outlets, and food-away-from-home, which
consists of meals, entrees, and other prepared foods sold in eating and
drinking establishments, and non-commercial (institutional) foodservice
outlets. To obtain the Food CPI, the separate indices of the at-home and
away-from-home segments are combined, using their respective expenditure
shares.

Food accounts for 13.8 percent of all expenditures in the All-Items CPI.
Of total expenditures, food-at-home accounts for 7.66 percent while
away-from-home accounts for the remaining 6.17 percent.

***May 2008 Retail Food Prices Compared to Last Year***

The CPI for all food in May 2008 is 5.1 percent higher than the May 2007
level. The food-at-home index is 5.8 percent above last May, while the
food-away-from-home index is 4.3 percent above last May. The all-items
CPI is currently 4.2 percent above the May 2007 level.

Beef prices are 1.5 percent above last May, as higher energy and feed
costs have begun to increase beef prices. Pork prices, while increasing
in recent months, are down 0.6 percent from last May's level. Strong
short-term pork supplies have been the main factor behind recent retail
price declines, but pork prices may rise over the next 2 years as
current supplies are sold and future production slows due to higher
production costs. Poultry prices are up 4.5 percent from last year at
this time. Higher feed and energy costs in 2007 and early 2008 have
caused poultry prices to rise faster than normal over the past 18
months.

Egg prices are 18.2 percent above the May 2007 level. Increased demand
overseas and higher prices for chicken feed lead to higher egg prices at
grocery stores. Dairy prices are up 11.0 percent from the May 2007
level. Within the dairy category, prices changed as follows: milk prices
are 10.2 percent above last May's prices; cheese prices are 14.0 percent
above last May's level; ice cream and related product prices are 5.9
percent above last May; and butter prices are 3.8 percent above last
May.

Fresh fruit prices are up 4.7 percent from last year at this time, with
apple prices up 7.4 percent and banana prices up 21.7 percent, while
orange prices are down 15.3 percent. Since last year at this time, fresh
vegetable prices are up 1.8 percent, with lettuce prices up 1.0 percent,
tomato prices up 4.0 percent, potato prices up 3.5 percent, and other
fresh vegetable prices up 0.5 percent.

Cereals and bakery product prices are up 10.5 percent from last year at
this time as higher wheat, corn, and energy prices have pushed up
production costs for these products. Sugar and sweets prices are 5.5
percent above last May. Within the nonalcoholic beverages category,
carbonated drink prices are up 2.8 percent from May 2007; coffee prices
are 8.5 percent higher than last May; and non-frozen noncarbonated
juices and drinks prices 7.7 percent above the May 2007 level.

***Why Higher Food Prices?***

Record U.S. trade, driven by economic growth in developing countries and
favorable exchange rates, combined with tight global grain supplies,
resulted in record or near-record prices for corn, wheat, soybeans, and
other food and feed grains in 2007 and 2008. For corn, these factors,
along with increased demand for ethanol, helped push prices from under
\$2 per bushel in 2005 to \$3.40 per bushel in 2007, and over \$7 as of
the middle of this year. Higher corn prices motivated farmers to
increase corn acreage in 2007 at the expense of other crops, such as
soybeans and cotton, raising their prices as well.

What effect do these higher commodity costs have on retail food prices?
In general, retail food prices are much less volatile than farm-level
prices and tend to rise by a fraction of the change in farm prices. The
magnitude of response depends on both the retailing costs beyond the raw
food ingredients and the nature of competition in retail food markets.

Several key factors influence how an input cost increase affects the
prices of food under conditions of competition. For a given increase in
an input\'s cost, the larger will be an increase in the food product\'s
price when:

●The share of the input in the total cost of producing food products is
larger.

●The input has fewer good substitutes in the food production
process---that is, few other inputs or processes could be used to
produce the food product.

●Consumers have few good substitutes for the food product, in which case
consumers do not decrease purchases substantially when the price is
higher.

●Prices are expected to remain high for a long period of time.

Retail prices for fresh fruits, vegetables, and eggs have a relatively
high farm value share compared to other commodities. Changes in
farm-level prices of these products have a larger impact on retail
prices as a result. There are also seasonality factors contributing to
volatility of produce (fresh fruits and vegetables) prices. Produce
supply and price variation are also influenced by extremes of weather
and growing conditions, such as droughts, floods, freezes, and pests.
Because most produce commodities are highly perishable, supply and
prices are highly sensitive to adverse growing conditions.

In contrast to raw commodities, the farm value share in many processed
products is quite small, which moderates the effect of rising prices.
For example, an 18-ounce box of corn flakes contains about 12.9 ounces
of milled field corn. When field corn is priced at \$2.28 per bushel
(the 20-year average), the actual value of corn represented in the box
of corn flakes is about 3.3 cents (1 bushel = 56 pounds). (The remainder
is packaging, processing, advertising, transportation, and other costs.)
At \$3.40 per bushel, the average price in 2007, the value is about 4.9
cents. The 49-percent increase in corn prices would be expected to raise
the price of a box of corn flakes by about 1.6 cents, or 0.5 percent,
assuming no other cost increases.

***Prices Paid by Food Service***

The Producer Price Index, measures prices received by processors,
suppliers, and wholesalers, depending on the product. Both farm and
processed products are included in the PPI. Similar to the CPI, the
indexes are reported monthly and annually. The PPI should more closely
represent the price change in food products purchased by food retailers
and food service operators. For many food commodities, the PPI is much
more volatile compared with consumer price indexes.

Food service operators purchase both products with a high farm value
component, such as milk or apple juice, as well as more highly processed
foods having lower commodity/farm value, such as cereal or pizza.
Suppliers to the food-away-from-home segment offer both traditional
foods requiring additional preparation, as well as highly processed,
value-added foods such as heat-and-serve entrees.

***Looking Ahead***

The Department's current long-term projections indicate that retail food
price inflation

will gradually moderate over the next several years. Continued expansion
of biofuels production will likely maintain corn and soybean prices at
historically high levels and livestock producers will adjust to the
increase in feed costs by reducing production, leading to higher retail
prices for beef and pork in the longer term. In contrast, future upward
movements in retail dairy product prices may be limited following the
strong increase in 2007. In addition, global agricultural production is
expected to rebound, especially for wheat, relieving some of the
pressure on retail food prices for cereal and bakery products. Of
course, future increases in retail food prices depend heavily on energy
prices and other food marketing costs.

Mr. Chairman, this concludes my statement. I will be glad to answer any
questions the Committee may have.