MARKETING                                         PIH-51


               How and Where is Price Established?

Steve R. Meyer, University of Missouri
Ronald L. Plain, University of Missouri
Glenn Grimes, University of Missouri

William T. Ahlschwede, University of Nebraska
Harold F. Breimyer, University of Missouri
Gene A. Futrell, Iowa State University
Richard L. Trimble, University of Kentucky

     The question ``How and Where is Hog Price Established?''  is
a  seemingly simple one. The pricing mechanism for hogs, however,
is complex. Prices for hogs, as for other commodities  traded  in
competitive  markets,  result  from the interaction of supply and
demand. But a long list of factors  affects  supply  and  another
long  list affects demand. In addition, the precise state of each
of the factors and the exact influence on supply and  demand  are
often not fully known at any given time.


     ``Demand'' for a product is not consumption. If true, demand
for  pork  and  hogs  would  be nearly synonymous with production
since, after making adjustments for imports, exports  and  carry-
over stocks, the pork produced in any given year is consumed. The
important question is: At what price? Demand  must  therefore  be
defined  in terms of both price and quantity. Demand is the rela-
tionship between alternative prices and the quantities of a  com-
modity  which  buyers  will purchase at those alternative prices.
Lines D1 and D2 in Figure 1 represent two such relationships.

     To understand the demand for pork, one  must  have  a  clear
idea  of two concepts:  change in quantity demanded and change in

     A ``change in quantity demanded'' occurs when only the price
of  pork  changes  and consumers respond by altering the quantity
they are willing to buy. This is illustrated in Figure 1  by  the
move from point A to point B in response to an increase in supply
from S1 to S2.  Quantity demanded changes from Q1  to  Q2.   This
adjustment  is  merely a move along D1, the existing relationship
between quantities which buyers will purchase and the alternative
prices  at  which  the  product  may be purchased. D1 is a demand

     A ``change in demand'' involves a shift of the entire demand
schedule.  This is represented by the shift of D1 to D2 in Figure
1. With supply constant at S1, price changes from P1 to P3 solely
because of the change in demand. Demand shifters for pork include
1) consumer preferences, 2) consumer income, 3) prices  of  beef,
broilers  and other competitive products, 4) prices of complemen-
tary products and 5) season of the year. Note  that  advertising,
promotion,  race,  religion  and culture are not listed as demand
shifters. These factors are manifested in  the  demand  structure
through consumer preferences.

     For many years, the demand for  pork  was  about  constant-a
given  quantity placed on the market brought about the same price
as before. During the '60s and '70s, though, the demand for  beef
increased thus putting pork in a disadvantageous position. In the
early '80s, however, demand  for  both  beef  and  pork  declined
markedly.  It appears that the demand for pork has shifted upward
somewhat since 1986, while the demand for beef  declined  through
1987.  Beef demand appears to have improved in 1988, but declined
again in 1989. The exact cause of these shifts is not known.  But
a combination of factors such as declining poultry prices, health
concerns over cholesterol and changing  lifestyles  probably  all
played a part.

     Finally, the nature of a given demand schedule, as  well  as
the  factors  which  shift  it, are vitally important. Demand for
pork is ``inelastic.'' This means that a given percentage  change
in  the quantity of pork placed on the market will cause a larger
percentage change in retail prices. And  of  course,  the  larger
percentage change in retail prices will be in the opposite direc-
tion of the change in supply. This  is  why  a  relatively  small
increase  (decrease)  in  pork supply often causes a surprisingly
large decrease (increase) in prices.  The relative size of  these
changes  when  demand  is  inelastic causes total revenue to fall
when quantities increase, and to rise when quantities decrease.


     ``Supply'' is not simply the quantity placed on the  market.
It is the relationship between alternative prices and the quanti-
ties producers are willing to place on the market at those alter-
native prices.  As was discussed for demand, changes in the quan-
tity offered for sale can be caused by  either  of  two  distinct
happenings:  change  in quantity supplied in response to a change
in price and a change in the supply schedule itself.

     A change in quantity supplied is simply a response to a dif-
ferent  price. If the price goes up while production costs remain
constant, a producer is willing to produce and sell more;  if  it
goes  down, a producer is willing to produce and sell less. These
reactions illustrate movement along a  supply  schedule.  Such  a
change  is  shown  by  the move from point A to point B on supply
schedule S1 in Figure 2. Note that an increase in demand from  D1
to  D2  caused  price to increase from P1 to P2 and quantity sup-
plied to increase from Q1  to  Q2,  yet  did  not  change  supply
schedule S1.

     A change in supply involves a shift  of  the  entire  supply
schedule. This is illustrated by the move from S1 to S2 in Figure
2. Supply shifters for hogs include 1) input prices (feeder pigs,
corn,  soybean  meal,  other  feed  ingredients,  labor, interest
rates, etc.), 2) opportunities for income from  alternative  farm
enterprises such as beef cattle or crops, 3) expectations of fac-
tors 1 and 2, and 4) time.

     Time is a factor because of the  biological  nature  of  hog
production.   Production responses to higher or lower prices will
be greater over longer periods of time than they will be  over  a
few  days  or  weeks.   In  Figure  2,  the  short-run production
response to the price increase P1 to P2 is a change from Q1 to Q2
(i.e.  move  along  supply  schedule  S1).  However, the long-run
increase (where ``long-run'' is a time period sufficient to allow
for  increased  gilt retention and, possibly, construction of new
facilities) is from Q1 to Q3 where supply schedule S2  intersects
demand schedule D2. Supply increases from S1 to S2 because of the
increased production capacity of a larger sow herd. The fact that
time  allows  for  more  production  response can be seen from Q3
being larger than Q2. Schedules S1 and S2  are  short-run  supply
schedules, and schedule LRS is the long-run supply schedule.

Supply and  Demand:  Retail  vs. Farm

     The demand for market hogs is derived from  the  demand  for
pork.  Having  an idea of the demand schedule for pork, retailers
deduct an amount sufficient to cover their costs  and  provide  a
profit and thus define a wholesale demand schedule for pork. Like
retailers, packer-processors then deduct an amount sufficient  to
cover  costs  and  provide a profit and thereby define the demand
for market hogs. So, the demand for market hogs is derived  down-
ward from the demand for pork.

     The supply of retail pork is  derived  from  the  supply  of
market  hogs. This is accomplished by all levels of the marketing
system adding their costs and desired profits to the cost of  the
purchased  item  (be that wholesale cuts or hogs). So, the supply
of pork is derived upward from the supply of market hogs.

     Marketing margins (the difference between retail  price  and
farm  price  for equivalent units of product) are most accurately
characterized as being the residual of retail price over the cost
of market hogs. Marketing costs (i.e.  costs of processing, pack-
aging and transportation) exert a major influence on the size  of
the  marketing  margin. The relative bargaining power of the par-
ties involved, however, is also an important factor.

     Hog slaughtering capacity is limited and tends to be  scaled
toward  an  average  crop of market hogs. As hog production drops
below historical averages,  the  bargaining  power  of  producers
improves.  Packers  need  hogs  to keep plants operating as effi-
ciently as possible. Toward this end, they compete actively  with
one  another  for  the  available  hogs, thereby driving live-hog
prices up relative to wholesale and retail prices. Packer profits
are  reduced  by both narrowing gross margins and higher per-unit
slaughtering and processing costs which  result  from  less-than-
optimal plant utilization.

     As hog production rises above historical averages,  producer
bargaining  power drops drastically. Packer slaughtering capacity
is sufficiently utilized, and packers are not forced  to  bid  as
actively  or  aggressively  as  when hog numbers are short. Farm-
level prices fall relative to wholesale  and  retail  prices  and
packer-processor profit margins increase.

     The latter of these results is often observed  by  producers
as inequitable.  When producer prices are lowest (with production
up)  packer-processor  margins  and  profits  are  greatest.  But
remember, when producer prices (and usually profits) are highest,
packer-processor margins and profits  are  smallest.   Therefore,
the  matter of what is equitable with regard to marketing margins
is very much in the eye of the beholder.  In any  event,  though,
the situation is marked by sharp fluctuations-or instability.

Price    ``Determination     and   Discovery''

     On the question of who or what determines prices, it is use-
ful  to  distinguish between price discovery and price determina-
tion. It is often easiest to discover prices at  assembly  points
such  as  terminal  markets and auctions, because it is here that
more than one buyer and seller will be present.  From  the  above
discussion,  it  should  be  obvious that this does not mean that
prices are determined at these points.

     Prices are determined by  buyers  and  sellers  acting  upon
their  knowledge of supply-demand information at a given point in
time. This information travels both horizontally through the sys-
tem (among farmers or producers) and vertically from consumers to
farmers and back again. Studies have shown that prices are simul-
taneously  determined  by everyone operating in the market and at
all levels of the system.

     There is some concern that the declining proportion of  hogs
which moves through terminal markets and auctions has impeded the
price discovery process. Whether this impediment has been  offset
by improvements in price and market information reporting systems
is, as yet, an unanswered question.

Types of Price Changes

     There are four basic types  of  price  changes  in  the  hog
industry.  They  are 1) trends, 2) cycles, 3) seasonal variations
and 4) day-to-day changes.


     Long-term trends in U.S. hog prices are  related  mainly  to
four  factors:  inflation, production efficiency, changes in con-
sumer preferences and marketing-distribution  service.  Inflation
affects hog prices simply by changing the value of the dollars in
which prices of hogs and production inputs are established.  Pro-
duction  efficiency  affects hog prices by shifting the supply of
market hogs and, consequently, pork. Supply increases (shifts  to
the  right  in Figure 2) when producers become more efficient and
thereby reduce production  costs.  Conversely,  supply  decreases
when  production efficiency falls. Consumer preferences influence
hog prices through their effect on retail (and  thus  farm-level)

     Marketing-distribution services can  affect  prices  through
their influence on the size of the marketing margin. If marketing
and distribution can be performed at  less  cost,  the  marketing
margin  may decrease without affecting packer-wholesaler-retailer
profits. This will allow either of two things (or  a  combination
of  them)  to happen. First, farm demand may increase relative to
retail demand, simply because the cost of marketing and distribu-
tion  activities  declines.  This  would  allow  producers to get
higher prices for the  same  amount  of  live  hogs  without  any
increase  in  retail  prices.  Second, retail supply may increase
relative to farm supply. Such a  shift  would  cause  the  retail
price  to fall thereby increasing the quantity demanded at retail
(and at the farm) without driving farm prices downward. Either of
these  scenarios results in higher revenues at the farm level and
demonstrates that producers have a definite stake in an efficient
marketing and distribution system.

     In addition, improved  marketing-distribution  services  may
not  reduce  the size of the marketing margin and still help pork
producers. This happens when  the  marketing-distribution  sector
(frequently  in cooperation with producer groups) develops better
products, more accurately identifies consumers' desires  or  more
effectively influences consumers' preferences through advertising
and promotion. All of these result in increased retail demand for
pork.  That is, the demand curve has been moved to the right.  If
marketing margins remain constant in  this  process,  the  entire
amount  of  the  increase  in  demand is passed along to the farm
level. Even if marketing margins increase, some  portion  of  the
increase  in  retail  demand  may  be  passed through to the farm
level. In this way, more effective  marketing-distribution  leads
to  value-added products from which producers may benefit even if
marketing margins increase.

     Trends emerge  from  the  interplay  of  these  factors.  If
improvement in production efficiency causes supply to increase by
a larger amount than changes in consumer preferences cause demand
to  increase,  the  price  trend  is  downward. This situation is
illustrated in Figure 3. On the other  hand,  if,  say,  improved
marketing-distribution  services  cause  demand  to increase by a
larger amount than supply increases, the price trend is upward as
in  Figure  4.   Other  situations  can be easily visualized from
these diagrams.


     Hog cycles are the single  most  important  source  of  wide
variations  in  hog  prices.  The time necessary for producers to
respond to changes in profitability is  one  reason  for  cycles.
This  factor,  however,  accounts mainly for cycles' lengths, not
their existence. For many years it has been assumed that the rea-
son for the existence of price cycles is that producers make pro-
duction decisions on the assumption that selling prices (or  pro-
fitability)  will remain about constant at existing levels. While
recent and expected profits may influence producers, it  is  hard
to imagine that producers who have seen cycles for many years are
naive or not able to learn from painful experiences.

     There is a more plausible explanation. Up markets bring with
them  many reasons for expansion even if producers do not believe
the favorable market will continue. These include  the  increased
availability  of  capital,  more positive outlooks of individuals
involved in management decisions (i.e. bankers, spouses,  consul-
tants,  etc.) and potentially high-tax liabilities which may make
equipment and breeding stock purchases (and depreciation on these
assets) attractive.

     Conversely, down markets are accompanied by the opposite  of
these  situations;  cash flow is tight or negative, attitudes are
negative and tax liabilities are of little concern.  Such  condi-
tions  may  result  in  liquidation even though producers believe
profitability will increase.

     There are two principal phases of the hog cycle: the  expan-
sion  phase  and  the  liquidation  phase.  Each  has distinctive
characteristics. During the expansion phase, hog prices are rela-
tively  high.  This encourages producers to increase the quantity
supplied in the long run. The culling rate on  sows  is  reduced,
sow  slaughter  drops  and  more  gilts are retained in herds for
breeding purposes.  These actions tend to reduce marketings (i.e.
the  quantity  supplied) in the short run and drive market prices
even higher. However, the increased number  of  breeding  animals
which  results  from  increased sow and gilt retention eventually
causes supply to increase. Because of the  inelastic  demand  for
pork,  the price declines, which result from the increase in sup-
ply, are often abrupt.

     The liquidation phase develops when prices turn lower.  Pro-
ducers  keep  fewer  gilts for breeding and cull more sows. These
added marketings put further downward pressure on prices  in  the
short  run  and  may  result in large quantities of pork and pork
products in the marketing channel and storage. Reductions in  the
breeding  herd will eventually cause supply to decrease which, in
turn, will cause prices to increase and start  the  entire  cycle


     Seasonal variations in prices are associated  with  seasonal
changes in both supply and demand. Seasonal variation in hog pro-
duction and consequent changes in hog slaughter and  pork  supply
cause  the  majority  of  these variations. Pork demand does have
some seasonal variations which can be important at certain times.
Examples  are the historical increase in the demand for spareribs
and bacon in summer months and in the demand for ham and  sausage
in the winter months.

     Hog prices have two fairly distinct seasonal peaks  and  two
valleys (Figure 5).  A major upturn in prices often occurs in May
or June due to reduced farrowings and litter sizes in the  winter
months.  Prices  usually  peak  in July or August.  A significant
price downturn usually runs from late August through October  due
to  the  increased  number of sows which farrow in the spring and
early summer months. A secondary price peak is common in  January
and  early February. The fall pig crop, normally smaller than the
spring crop, reaches market weight in March or April,  depressing
prices  again  during  this season. These lower prices may extend
into May or early June, depending upon  winter  weather  and  its
effect upon litter sizes and rates of gain.

     There is evidence that year-round farrowing has reduced sea-
sonal  variations  somewhat in recent years. As the proportion of
hogs produced in pasture farrowing and rearing systems  continues
to decrease, seasonal variations may diminish even further. It is
not anticipated that they will  disappear  because  the  seasonal
demand factors will still be present.

     Cold storage of pork products also tends to reduce  seasonal
price  fluctuations.  Packers build stocks in periods of high-hog
numbers and reduce stocks when numbers  are  less.  While  exces-
sively  large cold-storage stocks of pork can be negative factors
on hog prices in the short run, the process  of  building  stocks
may well reduce price declines at some times of the year.

Short-term Factors

     The major short-term factor  affecting  hog  prices  is  the
number  of hogs marketed (and thus slaughtered) on a given day or
in a given week. Figure 6  shows  average  weekly  slaughter  for
1980-89.  Excluding  dramatic  declines  in May, July, September,
November and December, which are attributable to holidays,  there
still  is  substantial  variability  in  weekly slaughter volume.
These fluctuations can have a major impact on live prices because
orders  for  wholesale  and  retail  cuts are taken by packers in
advance, and there is limited storage capacity for carcasses  and
wholesale cuts.

     Backlogs of hogs on farms can also  cause  short-term  price
changes.  Hogs are sometimes held on farms when 1) prices are low
and/or are trending downward, 2) producers are  preoccupied  with
farming  activities  or  adverse weather, 3) substantially higher
prices are expected and 4) hog prices are  high  in  relation  to
feed  prices.  In  all  cases, withholding hogs may have positive
impacts on prices in the very short-term, but may cause prices to
decline  sharply  when  the  animals  are finally sold at heavier
weights. In addition, these heavy hogs may  have  some  long-term
negative  impacts  on demand because of the increased fat content
of heavy carcasses and the negative  consumer  perceptions  which
fatty cuts may cause.

     Finally, short-term fluctuations in consumer demand for pork
may contribute to short-term price changes for market hogs. These
changes are most easily seen  in  the  marketplace  in  wholesale
prices.  Stocks  of wholesale cuts available on any given day are
largely fixed so day-to-day variation  in  the  prices  of  these
items is mostly a function of variations in consumer demand.

Pricing Systems

     The final source of variation in hog prices is  the  pricing
system.  The  systems  used are live weight and visual appraisal,
reputation and carcass merit. Great variation exists from  packer
to packer in the system used and even the characteristics of sys-

     The oldest method of pricing hogs is live weight and  visual
appraisal. This method is most commonly used at terminal markets,
country markets and auctions.  Some weight range is specified for
top  hogs by packer buyers. Discounts are applied to hogs that do
not fall into this weight range while both premiums and discounts
may be used for hogs that deviate from some norm in terms of fat-
ness and muscling. Degree of fatness and muscling are  determined
visually  by  the  packer buyer. Price premiums and discounts for
leanness and muscling are usually small in this system and there-
fore  penalize high-cutability hogs while favoring those with low

     Carcass merit pricing systems were based on USDA grades  and
carcass  weight  until the advent of the National Pork Producers'
Council (NPPC) Lean Value Buying  Guide  in  1981.   Since  then,
backfat  thickness  and,  in  the original NPPC system, degree of
muscling have replaced USDA grades in most packer  carcass  merit
pricing  programs.   Today, the terms ``grade and yield'', ``car-
cass merit'' and ``lean value'' are, for all intents, synonymous.
However,  individual packers have developed their own versions of
the   system   which   have   1)   base   carcass   weights   and
premium/discount  structures which differ from the NPPC guide and
2) usually omit premiums and discounts for degree of muscling.

     In all carcass merit pricing systems, prices  are  paid  for
carcasses,  not  live animals. A base carcass price is applied to
carcasses which meet certain standards  for  weight  and  backfat
thickness.  Premiums  are  paid  for  leaner carcasses of a given
weight or heavier carcasses with a given backfat thickness.  How-
ever, carcass weights must fall within a prespecified range to be
eligible for premiums. Packer employees do  all  of  the  carcass
measuring in today's systems. Only after carcass prices have been
determined is dressing percentage applied to convert prices to  a
liveweight basis.

     The proportion of hogs sold on a grade and weight system has
fallen  since  1985  after  twenty years of growth. In 1965, only
3.6% of all hogs were sold on a grade  and  weight  system.  This
percentage  grew steadily through 1985 when it reached 23.4%. The
percentage fell to 19.5% and 15.7%  in  1986  and  1987,  respec-
tively.  The  most  plausible explanation for this decline is the
emergence of new packers that employ a reputation pricing  system
in  which  premiums  and  discounts are based upon the historical
quality of animals sold by the individual  producer,  not  neces-
sarily the quality of the lot of hogs being sold.


     Hog prices are established by the interplay of  many  forces
ranging  from long-run changes in consumer tastes and preferences
to short-run factors such as the fat content  of  the  particular
hog being sold. Prices are frequently discovered at concentration
points in the swine-pork industry because it is at  these  points
that information is most easily disseminated and received.

     Cycles play an important part in the variation of hog prices
over  time. The biological lag of actual production to production
decisions explains the length of hog cycles. Recent and  expected
profitability,  the  availability  of  resources and attitudes of
influential parties are the reasons for  the  cycles'  existence.
Cycles  have  recognizable  expansion  and  liquidation phases of
which knowledge is important  if  producers  are  to  make  sound
financial, production and marketing decisions.

     Season affects hog prices for two reasons; variation in pro-
duction  and  variation in demand, with the former being the more
important. Hog prices usually peak in July and August  and  reach
lows  in October and November. A secondary peak usually occurs in
January and February while another seasonal low occurs  in  March
and April.

     Short-term moves in hog prices are a function of the  number
of  hogs marketed (and thus slaughtered), retail movement of pork
and the resulting changes in prices of pork carcasses and  primal
cuts.   Short-term fluctuations in demand are usually less signi-
ficant than those on the supply side.  The cut-out value of  pork
carcasses  and  the particular cost structures of pork processors
are balanced by packer  buyers  in  determining  daily  bids  for
market hogs.

Related Publications

     The following PIH factsheets contain additional  information
related to swine production.
PIH-6     Producing and Marketing Hogs Under Contract
PIH-12    Choosing a Slaughter Hog Market
PIH-19    Using Futures Markets for Hedging
PIH-24    Optimal Weight to Market Slaughter Hogs
PIH-109   Commodity Options as Price Insurance for Pork Producers
PIH-119   Understanding Hog Production and Price Cycles
PIH-123   Marketing Cull Sows

REV 5/90 (5M)

Figure 1. Change in demand and change in quantity demanded.

Figure 2. Change in  supply,  change  in  quantity  supplied  and
long-run supply.

Figure 3. Downward trend.

Figure 4. Upward trend.

Figure 5. Average weekly barrow & gilt prices  1980-89  of  seven

Figure 6. U.S. average weekly federally inspected hog  slaughter,

% Figures are available in hard copy.

Cooperative Extension Work in  Agriculture  and  Home  Economics,
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