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34 POTATO GROWER | MARCH 2022 DIGGIN' IN ECONOMICS | By Patrick Hatzenbuehler & Liang "Jimmy" Lu Do you remember the last time you heard that common refrain in the business community: "You have to spend money to make money"? Well, hearing that phrase may be more common in the 2022 crop year, and it may also need to be adjusted to: "You have to spend more money to make money." That is because the USDA Economic Research Service (ERS) estimates that nearly all farm input costs, inclusive of seed, electricity, fertilizer, fuel and oil, repairs and maintenance, labor, interest, and rent, will be higher for the 2021-22 crop year than the 2020-21 crop year. Pesticide is the only input category for which a year-to-year increase is not projected. The inputs with the largest changes from the last to the current crop year are fertilizer, with an estimated greater than 12% year-to-year increase; and fuel and oil, with an estimated greater than 32% increase. ERS projects that total farm production input costs will increase by more than 8% for this crop year compared to last year. The goal of this article is to discuss the profitability implications of this new, higher- production-cost environment for potato producers for the 2022 crop year. There are three key takeaway messages, and we discuss each in greater detail below. First, based on the ERS projections, potato producers should expect that production costs will be higher in 2022 than 2021. Second, whether these production cost increases matter for industry profitability depends on the price elasticity of demand for potatoes. Third, individual potato farm profitability will be influenced by the marketing arrangement and, specifically, the degree to which higher revenues and/or steady or lower costs can be obtained via risk management tools such as contracts. Cost Increases Since we have already discussed the projections of increased producer costs, the question that remains is, Will these cost increases necessarily imply lower profits? We argue that this is not the case in a general sense because higher costs can be passed on to other entities in the supply chain via higher potato prices. The key market characteristic that allows for costs to be passed along is the price elasticity of demand. Fortunately for potato producers, the demand for potatoes is price inelastic, with a value of -0.6 as estimated by Richards and Kaiser. There are two important properties of this elasticity estimate. First, it is negative and, therefore, consistent with the law of demand in which higher prices correspond with lower quantity demanded (and vice versa). Second, it is less than 1, which means that for any percentage price increase, quantity demanded decreases by a lower percentage. In a general sense, the more necessary a good is, the more price inelastic is its demand. Thus, since potatoes are the most popular vegetable among U.S. consumers, the demand for potatoes is more price inelastic than that for less popular vegetables. Let's do a brief example to illustrate why this is important. Suppose that the current price of potatoes is $10 per hundredweight and quantity demanded is 400 million hundredweight. Then, current potato industry revenue is $4 billion. Next, suppose the price increases by 10% to $11 per hundredweight. With an elasticity of demand of -0.6, this implies that quantity demanded will decrease by 6%, or 24 million hundredweight, to a value of 376 million hundredweight. Under this scenario, total industry-wide revenue after the price increase is a higher value of $4.136 billion. Thus, with price inelastic demand Implications of input price volatility on producer profitability Volatile Situation