Stop Blaming Rising Egg Prices on Market Power

By Brian Albrecht. Excerpt:

"But nothing in economics says large price changes require large reductions in supply. The size of the price change depends on both supply AND demand elasticities, which are about how easily the quantity supplied and quantity demanded respond to price changes.

In egg production, supply is essentially vertical in the short run due to chicken lifecycles. You can’t instantly produce more eggs when prices rise; you need to raise more chickens first, which takes months. This means that even small supply disruptions can generate large price changes.

Eggs are a perfect example of inelastic demand in practice. Jayson Lusk wrote a great post during the last major bout of avian flu. He said that a commonly assumed value for egg-demand elasticity is -0.15, meaning a 1% increase in price only reduces quantity demanded by 0.15%.[1] Put differently, if the quantity supplied drops by 1%, prices will rise by about 6.67%. In this case, the quantity of eggs dropped around 10%, which would generate a 67% increase in prices. Prices have been volatile, so it’s hard to get a true comparison, but prices have about doubled over the past year. That’s not far off the crude estimate.

This makes intuitive sense when you think about how people use eggs. They’re a dietary staple that’s difficult to substitute. You can’t easily switch to another product when making an omelet or baking a cake. Restaurants with egg-heavy breakfast menus can’t quickly overhaul their offerings. And since eggs are typically a small part of a household’s total food budget, price changes may not drive large consumption changes. When demand is inelastic like this, it takes bigger price increases to reduce the quantity demanded enough to match the lower supply.

Think about your Econ 101 graphs. With a vertical supply curve, any leftward shift of supply (from avian-flu losses) results in the same quantity reduction, but potentially huge price increases. This isn’t evidence of market manipulation but exactly what we expect to see in competitive markets with highly inelastic short-run supply.

There’s an impulse to believe massive price swings must reflect market power. I said “swings.” That’s not accurate. Only massive price hikes actually get blamed on market power. Price cuts don’t get attributed to cost savings being passed through by a monopolist.

There’s also a tendency to conflate high prices with rising prices when discussing market power. A firm with market power will typically charge high prices, but that doesn’t mean price increases indicate existing market power.

Conversely, firms in perfectly competitive markets may see dramatic price increases when faced with supply disruptions or demand spikes. The egg market illustrates this perfectly; we see rapidly rising prices, but that tells us nothing definitive about market power. We need to look at price levels relative to costs, not just price changes, to draw conclusions about competition.

But economic theory suggests that swings don’t clearly suggest market power. In fact, competitive markets often show larger cost pass-through than monopolistic ones. For simplicity, let’s assume a linear demand curve and a constant marginal-cost curve. These aren’t trivial assumptions, but the point is to show the mechanism, not to prove it is always true (it isn’t).

With perfect competition and a flat marginal cost curve, you’d see complete pass-through.

But if it were a monopoly seller, you’d only see 50% pass-through.

It’s maybe more intuitive to think of a drop in marginal cost and why that isn’t passed through. Marginal revenue drops faster than price. With a linear demand curve, the monopolist’s marginal-revenue curve is twice as steep as the demand curve. A $1 decrease in price would mean marginal revenue drops by $2. The monopolist really does not want to pass through that cost saving, which makes more sense. But if the logic applies when moving from c’ to c, it applies in the exact opposite way if we move from c to c’.

The takeaway here is that, even with identical cost changes, market structure significantly affects how much of that cost increase gets passed on to consumers."