bananas, inflation… you know the drill

Are you thinking what I'm thinking Glenn Stevens?

From feast to famine. Before cyclone Yasi came roaring inland, levelling three-quarters of Australia’s banana crop, the nation had been experiencing a banana glut.

Market commentary by the Australian Banana Wholesalers group, posted on the Australian Banana Growers’ Council’s website in the week before Christmas, complained of massive oversupply of bananas in the five major banana retailing markets.

In Adelaide: ‘‘Market is massively overloaded with fruit. Growers should only pack their absolute best because anything else than that will be worth nothing.’’ In Melbourne, market demand for bananas was ‘‘poor’’, but: ‘‘Demand becomes irrelevant with this much fruit to cope with. 198,000 cartons says it all. It’s a joke.’’ In Sydney, a record number of cartons of bananas – 247,143 – had arrived from growers: ‘‘Why are growers sending so much just before Christmas? Market has no chance of clearing for the next few weeks. Call your agent before you send is best advice.’’

That, of course, was before the floods in early January and now cyclone Yasi. Now banana growers outside cyclone-affected areas are looking forward to bumper prices as demand outstrips supply.

Strict banana quarantine laws mean growers are sheltered from international competition. Hence banana prices respond sharply to interruptions in supply, particularly from far north Queensland, which accounts for 85per cent of Australia’s banana production.

For other tropical fruits grown in the area, such as mangos, rambutans and pawpaws, supermarkets can supplement supply through imports. Sugar prices, for example, are not predicted to rise strongly, despite widespread destruction of sugar cane, because the market is global.

That’s the thing about prices – where competition is strong, a producer’s ability to lift prices is limited by consumer’s ability to switch to alternative suppliers. Where demand for a particular good is ‘‘inelastic’’ – that is, consumers can’t simply reduce their consumption in response to higher prices – prices can indeed rise sharply.

Remember Westpac’s banana smoothie explanation for why interest rates just had to rise after the global financial crisis? Costs had indeed risen for banks but, more importantly, lack of competition meant they were not forced to absorb those increased costs but rather could pass them on to customers. Home owners were hardly about to go switching banks when all of them were jacking up rates.

As for bananas, lack of other sources will limit supply and put upward pressure on prices. But people may start eating fewer bananas, limiting that pressure.

Such a change in consumption patterns, however, will elude the Bureau of Statistics when it measures inflation. The bureau does not change the basket of goods and services it measures each quarter, which is based on a five-yearly survey of household purchases. It will assume people keep buying bananas at the current rate.

The Reserve Bank, however, seems quite sanguine about the impact of recent natural disasters on inflation. Before Yasi hit, it described the floods as ‘‘unlikely to have a major impact on the medium-term outlook for inflation’’. It is still too early to assess the exact damage wrought by Yasi but we can expect the Reserve to look through the spike in banana prices, as it did after cyclone Larry in 2006.

THE IRVINE INDEX 05/02/2011

75% Portion of Australia’s banana crop destroyed by cyclone Yasi.

$400 million Value of banana industry.

$500 million Value of sugar cane destroyed by the cyclone, in addition to the $500million destroyed by the floods.

30% Portion of  sugar cane crop  grown north of Townsville.

73% Increase in raw sugar prices on global markets over the past five months as demand outpaced supply.

$1 billion Tourism industry’s estimated lost revenue and property damage due to the cyclone.

$2.96 Price of a kilogram of bananas earlier this week.

$15 Top-end forecasts for where banana prices are heading now.

$12 Banana prices hovered at this level for the best part of a year after cyclone Larry in 2006.

$99 million Insurance group QBE’s preliminary estimate of its costs from cyclone Yasi, on top of $100million in claims from recent flooding.

$10 million Total costs for Suncorp of cyclone Yasi insurance claims — smaller than you might think thanks to reinsurance policies.

0.5 Percentage points by which the government predicts the floods — not including the cyclone — will reduce economic growth this financial year.

0.25 Percentage points by which it predicts the floods will boost consumer price inflation this quarter.

Sources: Australian Banana Growers’ CouncilQueensland Tourism Industry Council, Canegrowers of Australia, Reserve Bank of Australia.

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3 Responses to bananas, inflation… you know the drill

  1. peter says:

    Thanks for the article Jess. How long should it reasonably take for a rise in banana prices to work it’s way through the system? I was considering this question last weekend as we were grocery shopping. In my local suburban supermarket chain…lets call it “W” …the price of bananas had doubled virtually overnight. My partner was about to potentially incite a riot in the fruit and veg section by declaiming against “blatant price gouging” and “exploitation” along with equally provocative epiphets when I decided to play the devil’s advocate. Marshalling all my imperfectly remembered undergraduate economics I suggested that it might be more a case of a retailer attempting to manage demand ahead of a possible run on remaining bananas caused by perceived imminent shortages. Not to mention costs at any point in the supply chain. Anyway I’m sure there a few shortcomings in my theoretical approach , but I might as well have suggested Tony Abbott be awarded the Nobel Peace Prize in the light of the response I got from my acerbic partner. Then again maybe it is just price gouging. (And yes “Marshalling” was a clever microeconomic pun)
    Thanks JI

  2. econogirl says:

    Hi Peter,
    Sorry, Somehow your comment went under my radar until just now…. Thanks for the post! I fear your partner will have trouble managing their blood pressure in supermarkets in the weeks and months ahead. As you note, the price response can happen immediately. Supermarkets will just charge whatever they think they can get away with. Perhaps they really were having trouble getting hold of supply already. Probably they were just anticipating shortness of supply to come. Perhaps even they anticipated a short term spike in demand for bananas (all that discussion made me crave a banana something wicked!). So I’m curious… Did W get away with it? Did you buy some bananas?

  3. peter says:

    Hi Jessica,
    Thanks for your very kind reply.
    In answer to your question regarding the bananas…the answer has morphed into another question altogether.
    We went to another supermarket “A” ( whose name is a an anagram of “Dali”), just across the carpark and found bananas and a lot of other stuff so much cheaper that the ‘W” chain, so naturally we made our purchase there.
    So from that experience, I am now wondering what role “price competition” genuinely plays in consumer behaviour. Why are there not more people in ‘A” , thereby driving down the prices in “W”??? I’m just intrigued by this
    Doing the Saturday morning shopping has become such a fertile area- I’m thinking of a blog around the theme of ‘Super Market Economist” addressing such questions as- does price competition matter?, is free trade better than fair trade?, is buying the cheapest product the most ethical shopping decision?, why do health food products cost so much?, does anyone actually drink lapsang souchong tea and why stock it?, is it the role of supermarkets to support charitable donations to flood relief? dan murphys or liquorland?
    Anyway, keep up the good work JI
    Peter

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