Wednesday, August 27, 2008

Short and Long Run Responses to Price Changes

Last fall, South Dakota businessman Steve Polley was scouting for ways to make some extra income when he saw a news headline: The price of hops was surging because of a global shortage.

From a recent Wall Street journal article on hops (the stuff that makes beer bitter and tasty).

When the price of an agricultural good goes up and there are profits to be made by selling it, people like Steve Polley, will try to start producing more. However, if you plant hops it takes several years to produce any. So if the demand for hops goes up because people like to drink beers like 60 minute IPA or Hops Slam, the price of hops in the short run is likely to surge up.
But after a few years all those farmers who planted additional hops start seeing yields. The price of hops will start to fall back after a few years (the long run). Or as the article put it

Some hops experts are skeptical about the prospects of the new growers. Ralph Olson, owner of Hopunion CBS LLC, a broker of hops, predicts many nascent growers won't be in business in a few years. Prices will come down, and insects can wreak havoc, he warns. Hops "are tough," he says. "The economics aren't there."

Same story can be told about coffee or oil. It takes a few years to adjust to a change in prices.
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