We spend a lot of time talking about the elasticity of demand: That is, how consumers react to higher (or lower) prices. Just as important, but less often mentioned--probably because it's harder to measure--is the elasticity of supply: How does the amount producers produce react to higher prices?
Some kinds of fertilizer have nearly tripled in price in the last year, keeping farmers from buying all they need. That is one of many factors contributing to a rise in food prices that, according to the United Nations’ World Food Program, threatens to push tens of millions of poor people into malnutrition.
Now for some economics.
Point 1: Supply curves slope upward. As prices increase, producers produce more. This seems obvious, but the reason for upward sloping supply curves is often less than obvious. Most people think that producers produce more at higher prices so they can earn higher profits. That is partially true, but ask yourself, if the price rises, why would a producer ever stop producing? The only reason a producer stops producing--at least over short periods of time--is that the cost of producing additional units must increase to the point that it is not profitable to produce more. In other words, it's the cost of producing the next unit that matters. We call that the marginal cost. When the marginal cost of producing the next unit exceeds the price, the producer stops producing additional units. That brings us to point 2.
Point 2: How fast the marginal cost rises, and therefore how much additional output producers produce when prices rise depends on how fast producers can ramp up production. We call this the elasticity of supply. If producers can quickly increase production when prices increase (marginal costs increase slowly), supply is elastic. If producers have trouble reacting (marginal costs increase quickly), supply is said to be inelastic.
So now let's use this to look at the fertilizer market.
The squeeze on the supply of fertilizer has been building for roughly five years. Rising demand for food and biofuels prompted farmers everywhere to plant more crops. As demand grew, the fertilizer mines and factories of the world proved unable to keep up...The demand for fertilizer has been driven by a confluence of events, including population growth, shrinking world grain stocks and the appetite for corn and palm oil to make biofuel. But experts say the biggest factor has been the growing demand for food, especially meat, in the developing world.
Demand for fertilizer is increasing (shifting to the right) due to increasing populations and increased demand for biofuels--damn ethanol dominoes. Simple supply and demand analysis tells us demand increases will cause the price of fertilizer to increase. But how much? The article indicates that fertilizer mines and factories are having trouble keeping up. In other words, the supply of fertilizer is inelastic. The more inelastic supply, the faster prices rise when demand increases.
Prices at a terminal in Tampa, Fla., for one fertilizer, diammonium phosphate, jumped to $1,102 a ton from $393 a ton in the last year, according to JPMorgan Securities, which tracks the prices. Urea, a type of granular nitrogen fertilizer, jumped to $505 a ton from $273 a ton in the last year.
If supply were more elastic, then producers would just ramp up production quickly and the demand increase would lead to a much smaller price increase. But since fertilizer producers can't react quickly, the price rises quickly to serve as a rationing mechanism for fertilizer.
What effect does increasing fertilizer prices have? Fertilizer is an input into food production. As fertilizer prices rise, the supply of food decreases--causing less food availability and higher food prices. An uncomfortable situation Also, higher fertilizer prices lead to a search for substitutes to fertilizer.
Protests over high food prices have erupted across the developing world, and the stability of governments from Senegal to the Philippines is threatened.
In the United States, farmers in Iowa eager to replenish nutrients in the soil have increased the age-old practice of spreading hog manure on fields. In India, the cost of subsidizing fertilizer for farmers has soared, leading to political dispute. And in Africa, plans to stave off hunger by increasing crop yields are suddenly in jeopardy.
But unfortunately, there aren't a lot of substitutes for fertilizer:
Agriculture and development experts say the world has few alternatives to its growing dependence on fertilizer. As population increases and a rising global middle class demands more food, fertilizer is among the most effective strategies to increase crop yields.
“Putting fertilizer on the ground on a one-acre plot can, in typical cases, raise an extra ton of output,” said Jeffrey D. Sachs, the Columbia University economist who has focused on eradicating poverty. “That’s the difference between life and death.”
And then of course, there's the environment:
Once new supplies become available, the rising use of fertilizer will still pose difficulties.
Environmental groups fear increased use, particularly of nitrogen fertilizer made using fossil fuels. Because plants do not absorb all the nitrogen, much of it leaches into streams and groundwater. That runoff has long been recognized as a major pollution problem, and it is growing.
A barometer of the pollution is the rising number of dead zones where rivers meet the sea. In the Gulf of Mexico, for instance, nitrogen runoff from fields in the Corn Belt washes downstream and feeds plant life in the gulf. The algae blooms suck oxygen from the water, killing other marine life.
More than 400 dead zones have been identified, from the coasts of China to the Chesapeake Bay, and the primary reason is agricultural runoff, said Robert J. Diaz, a professor at the Virginia Institute of Marine Science.
“Nitrogen is nitrogen,” Professor Diaz said. “If it’s on land, it produces corn. If it gets in the water, it produces algae.”
This month, a United Nations panel called for changes in agricultural practices to make them less damaging. The panel recommended techniques that offer some of the same benefits as chemical fertilizer, like increased crop rotation with legumes that naturally add some nitrogen to the soil.
But others say those approaches, while helpful, will be not be enough to meet the world’s rapidly rising demand for food and biofuel.
“This is a basic problem, to feed 6.6 billion people,” said Norman Borlaug, an American scientist who was awarded a Nobel Peace Prize in 1970 for his role in spreading intensive agricultural practices to poor countries. “Without chemical fertilizer, forget it. The game is over.”
