The Economics of Regulations on Hen Housing in California

Transcription

1 The Economics of Regulations on Hen Housing in California Prepared for Presentation at the 2010 annual meeting of the Southern Agricultural Economics Association Daniel A. Sumner, William A. Matthews, Joy A. Mench and J. Thomas Rosen-Molina * Sumner is the Frank H. Buck, Jr. Professor in the Department of Agricultural and Resource Economics, University of California, Davis and Director of the University of California Agricultural Issues Center where Matthews is post-doctoral scholar and Rosen Molina is a research associate. Mench is a professor in the Department of Animal Science at UC Davis. 1

2 The Economics of Regulations on Hen Housing in California Introduction Law and regulation has long attempted to limit cruelty to animals. Recent efforts to restrict treatment of farm animals, such as the recent California ballot initiative, go beyond general limits to proscribe specific housing arrangements. Economic analysis of response on the part of buyers and sellers to such proscriptions can consider impacts on production, prices, consumption and related measures, without opining on the moral underpinnings of animal welfare measurement. As attention to restrictions on animal agriculture has expanded understanding the economic implications of specific policy measures has increased as well. Such economic analysis is useful both for the ex ante policy debate and for ex post projections of industry adjustments. This paper considers the economic implications of new hen housing regulations on the shell egg industry in California. To consider these implications, we first must address egg production and the market for eggs in California. We then outline costs of production of eggs in California and present new data on how production costs differ in different housing systems for egg-laying hens. With this background, we analyze how complying with the new law will affect the quantity and location of eggs produced and consumed in California. The Proposition and Scheduled new Regulations In the November 2008 General Election, California voters voted two to one for a proposition (know as Proposition 2) establishing the Treatment of Farm Animals Act, which mandates limits on the minimum space required for confine of certain farm animals (veal calves, pregnant pigs and egg-laying hens). Enforcement of the new regulations is scheduled to begin on January 1,

3 Before the end of the six year span from the election to the start of enforcement, agricultural producers within California will be required to comply with the law, stated as follows. In addition to other applicable provisions of law, a person shall not tether or confine any covered animal, on a farm, for all or the majority of any day, in a manner that prevents such animal from: (a) Lying down, standing up, and fully extending his or her limbs; and (b) Turning around freely. (California Health and Safety Code Section 25990) As indicated, the parameters that define the mandated minimum size do not constitute a specific measurement but rather are dictated by the ability of the animal to perform particular behaviors. For egg-laying hens confined for the purpose of egg production, fully extending his or her limbs is further defined as follows. "Fully extending his or her limbs" means fully extending all limbs without touching the side of an enclosure, including, in the case of egglaying hens, fully spreading both wings without touching the side of an enclosure or other egglaying hens. (California Health and Safety Code Section 25991(f)) Egg Supply and Demand in California This section provides some background necessary to understand the economic situation of the California egg market prior to the passage of Proposition 2. Large scale commercial egg production in California began in the 1920s with the development of the artificial incubator, increased availability of commercial feed and the advancement of flock management techniques, such as the use of cod liver oil to provide vitamin D in place of sunshine. These changes fostered development of caged housing systems (Rahn 2001, p.2). Advantages of indoor caged housing systems included saving labor and land as well as the separation of laying hens from their manure and the reduction of parasitic infections such as coccidiosis and round worms (DAFF 2007, p.2). For these reasons, the cage system was 3

4 widely adopted during the 1930s, and became the most popular system for producing eggs in California (Rahn 2001, p.1). California egg producers continued to modify their cages and increase laying hen density. By the 1970s, the most popular cage sizes were the 20 x 16 cage with six or seven birds, and the 12 x 18 cage with three or four birds. California s laying hen population reached nearly 42 million in The ensuing production capacity provided a shell egg supply to California consumers that was approximately 40 percent greater than in-state demand (Bell, 1988 p.4). Since 1971, the combination of California s high feed costs and lower average prices from eggs shipped out of state led to a decline in California s laying hen population. Between 1971 and 1995, California s egg-laying flock declined from nearly 42 million to about 25 million laying hens. However, due to increases in egg production per hen, overall egg production in California declined less rapidly than the number of laying hens. The decrease in laying hen population in California coincides with an increase in California s human population from just over 20 million people in 1971 to over 36 million people in This population growth raised the demand for eggs in California. During the 1960s and 1970s, California was an exporter of eggs, averaging a 14 percent ratio of exports to production between 1967 and 1975 (Smith 1983, p.12). Shipments from other states now account for most of California consumption of egg products and about one-third of California consumption of shell eggs. From the early 1970s to the mid 1990s, California s laying hen population fell by an average of nearly four percent per year, and California s egg production fell by an average of 3.5 percent per year. California s share of U.S. table egg production fell from over 12 percent to about 10 percent over this period. 4

5 In 2001 and 2002, California had approximately 23 million laying hens, and received about 1.2 billion shell eggs from other states (Bell 2008a). Toward the later part of 2002 and into early 2003, California experienced an outbreak of Exotic New Castle Disease, which reduced the state hen population by about 3.5 million hens by July Shipments into California responded by increasing their 2003 shipments by about 90 percent to 2.2 billion eggs. Shipments into California reached more than 2.4 billion eggs in 2006 and 2007 (Bell 2008a). In 2008, California farms had just over 19.9 million laying hens and produced close to five billion eggs. The total value of egg production was roughly $440 million in 2008(USDA, NASS 2009). California production and value of table eggs is about two percent below $440 million to account for the small quantity of hatching eggs that continue to be produced within the state. The production of table eggs in California in 2008 accounted for approximately six percent of all U.S. table egg production, and placed California as the fifth largest table egg producing state in the country (USDA, NASS 2009). California s productivity as measured by egg output per laying-hen has been below the national average for table eggs for many years (USDA, NASS 2009). The 2007 Census of Agriculture reports that over 5000 farms in California have laying hens aged twenty weeks or older. However, only 60 of these farms had more than 20,000 laying hens on hand and only 37 farms had more than 100,000 laying hens (USDA, NASS 2007). According to Watt Poultry s Egg Industry (2007), there were four farms in California with at least a million laying hens on hand. The largest had about three million hens and the average flock size among these farms was about 2.2 million. Thus, about 46 percent of egg production came from four farms, about half of the production from another 56 farms and the rest from 5

6 thousands of very small egg operations. Of course, these data do not account for eggs produced out of California and shipped into the state. Several of the larger operations in California also have egg production in other states. For example, Norco Ranch is owned by Moark LLC, which is itself a subsidiary of Land O Lakes, a farmer cooperative based in Minnesota. Moark LLC has 17 egg-production facilities spread across 8 states and the company markets more than 24 million hens ( 2008). It is the third largest egg producer in the country and four of its shell egg facilities are located in California. Based on information from industry sources and hen numbers reported we estimate that about 93 percent of California egg production is marketed in the state as shell eggs, and about 7 percent is marketed as powder or liquid eggs, sometimes called breakers. (Bell 2008b) Per capita consumption was about 206 eggs per person in 2008, a decrease of 5 percent from peak per capita consumption in 2002 (USDA NASS, Bell 2008a). Total consumption of shell eggs was 7.5 billion with consumption of eggs in all forms estimated at 8.2 billion in 2008 (Bell 2008a). Egg production costs, prices and differences across regions and housing systems This section provides data on table egg production costs and major categories of costs. Regional patterns in costs, focusing on transport costs for feed and eggs, are used to better understand the potential responses of egg shipments to changes in relative costs. We then develop estimates of cost differences by housing system. Finally, data is presented on prices of eggs produced in different systems. Producers net returns depend on the difference between the egg revenue and the cost to produce those eggs. More than 80 percent of the variable costs, and two-thirds or more of the 6

7 total costs of egg production can be attributed to two factors: feed and pullets (Rahn 2001, p.12). Feed and pullet costs vary from year to year as, which contributes to variable net returns. Overall feed costs are determined by the amount of feed necessary for a laying hen to produce a dozen eggs, known as the conversion ratio, and the per-unit price of feed. Due to innovations in hen genetics the conversion ratio has gradually improved over the past few decades (Aho 2002 p.804). Individual producers can improve the conversion ratio only slightly through better management. The price of feed, consisting mainly of corn and soybean meal, fell in real terms since the 1980s but spiked in 2007 and 2008 and has remained above the long term trend since then. (USDA, NASS 2008) Cost of pullets is another significant cost of production that differs by location over time. Most egg producers purchase day-old chicks or ready-to-lay commercial pullets from hatcheries that specialize in raising flocks of up to 200,000 pullets at a time. The cost to raise the chicks to maturity, when they enter the laying flock, represents the second highest expenditure for most commercial egg producers (Bell 2002a). The cost of a pullet entering the laying flock is also dependent on the price of feed. Pullet costs per dozen are also determined by the age at which the hen begins laying eggs, since if hens come into lay late there will be a shorter laying cycle, typically resulting in pullet costs being amortized over fewer eggs. Mortality rates during the period before the pullets enter the laying flock and over the period in which the flock is in the laying facility both affect pullet costs per dozen eggs by affecting the total number of eggs per pullet. This section compares the costs per dozen eggs for cage systems typically used by major producers that supply most of the conventional eggs on the market with non-cage barn systems that are used to supply most of the non-cage or cage-free eggs on the market. We do not 7

8 explore costs for free range, pasture raised or organic eggs. Because detailed regulation have yet to be written we do not know precisely what rules will apply in 2015 to hen housing under California law. Costs of egg production differ by housing system. Using evidence from published literature and information provided by California producers we examine the differences in costs of feed, pullets and other expenses in terms of costs per dozen marketable eggs. Most important, feed usage per dozen eggs is considerably higher in non-cage systems than in typical cage systems. The greater freedom of movement allowed by the non-cage system increases laying hens physical activity, and the lower stocking density and open space reduce the efficiency of maintaining optimal house temperatures. Both of these circumstances lead to higher feed consumption (Gibson et al. 1988; Appleby et al. 1992, p.59). Second, pullet costs per dozen eggs represent the cost of the hen as she enters the laying house divided over her lifetime production of eggs. Pullet cost per dozen marketable eggs is influenced by the original cost of the chick, rearing costs and the number of marketable eggs the hen produces over her lifetime. Evidence summarized here suggests that marketable egg production per hen is lower and mortality is higher for non-cage housing. In California, producers tend to use pullets raised in cage systems in their cage laying hen facilities and pullets raised in non-cage systems in their non-cage egg-laying facilities. Pullets entering non-cage housing also tend to be brown breeds, which contributes to higher chick costs and higher pullet feed consumption. This leads to higher costs for pullets entering the laying flock in non-cage housing rather than cage housing. Data supplied by California producers that use both conventional cage systems and noncage systems indicate that non-cage production systems have higher hen mortality rates, in conjunction with an overall shorter productive hen lifespan. Producers using both systems report 8

9 that hens in non-cage systems lay eggs, on average, for 60 weeks, compared to 80 weeks for hens in a cage housing system. Also, producers report a higher mortality rate for non-cage hens, which results in a loss of production over the lifespan of the flock. The scientific literature also suggests that laying hens that are kept in non-cage systems tend to have higher mortality rates than hens in cages. Egg-laying hens kept in the large groups characteristic of non-cage systems are at increased risk of exhibiting cannibalistic behavior (an abnormal behavior where the hens tear at and consume the flesh of other hens) compared to conventionally-caged hens (Appleby et al., 2004). Furthermore, unlike caged laying hens, hens in non-cage systems are usually exposed to their own droppings, which increase their risk of contracting disease and parasitic infections (EFSA, 2005). A review of published studies shows that there can be considerable variation in hen mortality rates during a laying cycle (e.g. EFSA, 2005), even within particular housing systems. Nonetheless, most experimental studies and onfarm comparisons have reported that mortality is higher in non-cage systems than in conventional cage systems. Several European studies supply evidence on this point (Blokhuis 2008, Elson 2008, Rodenburg et al. 2008, LayWel 2007, Aerni et al. 2005). Labor costs differ between systems and also depending on the configuration of particular systems. The adoption of the cage system has allowed the widespread automation of the daily tasks performed by egg producers. This has led to lower labor use per egg, as feed and water distribution, manure disposal, and egg collection and packaging are all performed by machines. As a result, one worker can usually oversee more than 100,000 caged laying hens, possibly achieving labor costs as low as one cent per dozen (Bell 2002b). In comparison, a worker in a non-cage operation will typically manage 30,000 hens. Automation of egg collection is possible within non-cage systems, but eggs that are not laid in the nest box must still be collected by 9

10 hand. Other contributors to higher labor costs are associated with maintaining good litter quality and nest box cleanliness, and identifying and catching sick and injured hens. Information from California producers indicate that non-cage systems require a substantially greater amount of effort to manage than a cage system (Foster 2008). Eggs from non-cage systems are more likely to be uncollectable, downgraded or unmarketable because some of these eggs are laid outside of the nest box (so-called floor eggs), where they may be eaten by the hens or become cracked, dirty, and/or contaminated with bacteria. This is particularly a problem in free-range systems (EFSA, 2005). This can be a major source of sanitary and economic problems in non-cage systems. Typical floor laying rates range from two percent to 10 percent (EFSA, 2005). Eggs from non-cage systems are more likely to be downgraded than those from cages (EFSA, 2005). Causes of downgrading are stains, blood spots, cracks, pimpling and holes. The shells of eggs produced by hens in non-cage systems are thinner than those of the eggs produced by caged hens, which is a risk factor for cracks, although some studies find the percentage of cracked eggs to be similar between non-cage systems and conventional cages (see EFSA, 2005). The LayWel (2007) database from Europe probably provides the most comprehensive information available about egg production and quality characteristics in different systems. These data show that about five percent of eggs were laid outside of the nest boxes in the noncage systems included in the analysis. Eggs from non-cage systems were more likely to be soiled (7.7 percent to 8.4 percent) than those from cage systems (4.9 percent). Of the eggs collected, 7.8 percent of eggs from non-cage systems were downgraded as compared to 6.5 percent from conventional cages. Overall production was lower in non-cage systems (76 percent to 80 percent per hen per day) than in conventional cages (86 percent per hen per day), likely due to 10

11 uncollectable eggs. In European data, the eggs from the non-cage system were also on average smaller (62 to 63 grams) than those from the cage system (65 grams). The total egg mass produced was thus greater (21.4 kg) in cage than in non-cage (19.4 kg) systems. These results were similar to those of previously published system comparisons (see EFSA, 2005). For conventional cage systems, housing costs are a relatively small part of total egg production costs. Nonetheless, cages represent the durable asset that limits the number of hens and quantity of egg production in the short run (Rahn 2001, p.12). The initial investment per facility involved in constructing a typical cage system is significantly higher than the investment required for a non-cage floor operation (Bell 2002, p 1008). However, since non-cage operations have many fewer birds per facility, the housing costs per bird or dozen eggs are higher in non-cage systems. In our categorization, housing costs for each system include the cost of the physical structure, the equipment within the structure, the utilities to operate the equipment and the maintenance, service and supplies necessary to maintain operations. The complex design and larger space requirements per bird of a modern non-cage layer house make this system more expensive to construct per bird. Once constructed, non-cage houses take more resources per bird to maintain and service than a cage system. For example, design limitations often make manure collection and removal from a non-cage system more complicated and costly. Clearly, costs also differ across flocks and across farms within housing systems. These within-system cost differences may be attributed to several factors. The performance of a flock depends on random disease experience, weather and similar variables outside producer control. California egg producers may manage as many as 25 different flocks of various sizes at one time. Each flock has a different rate of mortality and rate of lay, and these different rates cause differences in costs between flocks. Furthermore, comparisons over time depend significantly on 11

12 feed prices during the period. For instance, the average cost of 100 pounds of pullet feed delivered in California rose from $8.03 in 2006 to $10.32 in 2007, a jump of approximately 29 percent from one year to the next. The range of estimates presented in Table I incorporates the experience of California farms that produce eggs using both conventional cage housing systems and non-cage systems. These costs apply to non-cage systems actually in use, and do not include costs for organic or free range systems. These estimates are derived from several farms over the last three years and the range in costs reflects differences in the experience of individual flocks with the feed costs that applied during the period examined. Some variation across farms reflects differences in accounting systems in terms of how costs are categorized. All these differences are reflected in the ranges for each cost category. The general experience is that non-cage housing systems have substantially higher cost in each of the main categories. Using the midpoints of the ranges reported, pullet cost per dozen for non-cage systems is approximately 5.5 cents per dozen higher, or about 55 percent higher, than for conventional cage systems. Feed costs for the laying hen flock are about six cents per dozen higher for the non-cage housing or about 17 percent higher. This relatively small percentage in feed cost differential (compared to the differences in other cost categories) is accounted for by the very high feed price in 2007 and A high base feed cost implies a lower percentage difference for the same difference in cents per pound. Per-dozen housing and labor costs were also substantially higher for non-cage systems. These relatively large differentials measured at the midpoint reflect very high housing and labor costs for some non-cage systems. Based on the midpoints of the ranges reported for the four itemized costs, the non-cage system's production costs per dozen were 58 percent higher than those for the cage systems used 12

13 on these farms. At the midpoints, the sum of itemized costs are $0.94 per dozen in the non-cage systems and $0.595 per dozen in the cage systems. Based on the midpoints of the reported total costs, non-cage system costs of production per dozen were about 41 percent higher than those for the cage systems used on these farms. Total cost at the midpoints are $1.05 per dozen for the non-cage systems and $0.745 per dozen for the cage systems. Note that these data do not account for the finding reported above that eggs produced in non-cage systems tend to be smaller than those produced in cage systems. Another way to use the cost data provided by farms is to consider the low cost cases with each system. Such a calculation is appropriate if these costs reflect the best production methods within each housing system, and reflect disease and feed costs that apply in more normal conditions without considering some high-cost cases that raise the median. These calculations using the low-cost cases are reported in the final column of Table I. Using the low costs for each cost category under the two systems, the sum of the cost differential is $0.20 per dozen. That is, itemized costs are about 44% higher for the non-cage system. Using the low cost cases for reported total costs, the differential is $0.40 per dozen. That is, total costs are about 70 percent higher for the non-cage system. With a great variety of evidence, we cannot provide precise estimates of each of the cost differences for underlying factors. The direction and range of magnitudes are well documented, however. For example, average mortality is clearly higher for the non-cage systems and this contributed to the higher pullet costs per dozen eggs. The data also clearly show higher feed, housing and labor costs per dozen eggs. All the evidence indicates cost differentials of more than 20 percent and likely perhaps substantially more. Cost issues and the impact of California hen housing regulations 13

14 The California egg industry remains a significant part of the egg supply in the United States. Yet, as explained above, while the demand for eggs in California grew over the past four decades, egg production in the state fell. This means that rather than ship eggs to the rest of the United States, California is now a net destination for eggs produced elsewhere. California produces about 6 percent of the table eggs in the United States and, based on population, consumes about 12 percent. These figures imply that about half the eggs consumed in California are shipped in. Some of the net shipments into California come in the form of processed food products (bakery products, noodles and similar products) and some in the form of liquid eggs used in the food processing and food service industries. But a substantial number of eggs are shipped as shell eggs for the wholesale and retail markets. Given that almost all California production is distributed in state as shell eggs, based on USDA and other data summarized previously, we estimate that about one-third of the shell eggs consumed in California are shipped in from other states. This fact is important to our assessment of the likely impact of Proposition 2 because it indicates that the egg industry in California faces competition from eggs produced in other states. The competitive balance among regions makes California production vulnerable to any factors that raise California costs relative to costs in other states. The Treatment of Farm Animals Act eliminates the option to house egg-layers in conventional cages for eggs produced in California without limiting production rules in other states. Data presented above show that this will raise California production costs substantially. The increase in costs will take two forms, both of which are important. First, variable costs of production will rise by at least 20 percent and probably substantially more. Underlying these higher costs per dozen eggs are higher feed use per bird, higher cost per pullet, lower average productive life of a hen, higher mortality rates, fewer eggs 14

15 of premium size or acceptable marketability per hen, fewer birds per facility and higher labor costs per hen and especially per egg. The second major cost impact of the new regulation is that compliance will require substantial investment in new or retrofitted housing facilities. Based on information provided by farm accountants, a new or converted non-cage housing facility costs in the range of $10 to $40 per bird (Marcus 2008). With more than 18 million hens in cage housing in California, about 600 new or retrofitted buildings, each housing about 30,000 hens, will need to be constructed by January 1, 2015 when the enforcement of the regulations begins. With cost per house of between $10,000 and $30,000, the capital investment required to provide approved housing for those hens is between $300 million and $900 million. Producers would also need access to more land and face zoning and other regulations that have limited relocating or expanding facilities for animal agriculture in California. Naturally, such major investments in new housing facilities would be undertaken only if farms had confidence that the long-lasting investments could be repaid with net returns over the productive life of the investment. However, as established earlier, the regulations will cause California variable costs of production to rise relative to variable costs for out-of-state eggs, where no new capital investment would be mandated. The California egg industry has made substantial investments in non-cage housing systems in recent years in order to supply eggs to the specialty markets for non-cage and organic eggs. The market for eggs from non-cage housing systems remains a very small share of the total market for table eggs. Nonetheless, these investments can be profitable for a limited volume of production when the eggs are marketed to supply specialty egg demand at high prices. Both in-state and out-of-state producers supplying these specialty markets face similarly high 15

16 costs, and therefore the price of specialty eggs is substantially higher than the price of eggs produced under conventional cage housing systems. It is important to note, however, that there has been no investment in non-cage housing facilities by farms with an expectation that they will be able to compete directly with eggs produced using conventional cage housing systems. The lack of such investment is further confirmation that farms in the business of making these investments have not found non-cage housing systems cost-competitive, unless they are able to supply eggs to a market where other farms are also restricted in the housing systems allowed. Economic modeling of hen housing restrictions Demand for eggs depends on price and a parameter representing relative consumer preference for eggs produced using a non-cage housing system. For simplicity consider a demand function for eggs of log differential form so that the percentage or proportional change in the demand for eggs is given by (1) dlnq d = η(dlnp - dlnb), where Q d is quantity demanded for California eggs, P is price, η is the price elasticity of demand facing California egg producers, which is negative, and B represents the additional willingness to pay for eggs produced using a non-cage housing system. The term dlnb represents a percentage or proportional increase in the willingness to pay or the increased demand price for eggs produced under the non-cage housing system. Notice that as willingness-to-pay under the alternative rises, the quantity demanded rises. Analogously, consider the simple supply function where the percentage or proportional change in quantity supplied takes the form (2) dlnq s = ε(dlnp - dlnc), 16

17 where Q s is the quantity of California eggs supplied and dlnc is a vertical cost shifter reflecting the added marginal cost of producing eggs using the non-cage alternative to the conventional cage environment. The elasticity of supply, ε, is positive because the higher the price, the more eggs will be supplied to the market. Notice that as costs rise, the quantity of eggs supplied falls. To determine the effects of the shift to the alternative system we use the equilibrium condition: (3) dlnq d = dlnq s = dlnq, and incorporate equations (1) and (2), so that (4) ηdlnp+ ηdlnb = εdlnp - εdlnc. Solving this equation for the proportional change in price as a function of the elasticities of demand and supply and the two shifters yields (5) dlnp = [-ε/(η-ε)](dlnc) + [-η/(η-ε)]dlnb). This expression shows that the price of eggs rises with the increase in the cost of production due to the alternative housing system. This term is positive because the elasticity of supply is positive and the elasticity of demand is negative so the denominator is negative. Inserting the expression for dlnp in equation (5) into either equation (1) or equation (2) yields the following equation for the effects of the change in housing system on the new quantity of eggs: (6) dlnq = [-ηε/(η-ε)](dlnc - dlnb). In equation (6), we see that the larger the cost increase from the new housing system, the fewer eggs will be sold ([-ηε/(η-ε)] is negative). However, the larger the increase in the willingness to pay for eggs produced under the alternative system, the more eggs will be sold. 17

18 We expect the quantity effect will be negative because the eggs produced under the alternative system are available currently and command a very small share of the market. That means the additional willingness to pay by consumers must be small relative to the additional cost of production for the eggs under the alternative housing system. We therefore characterize the regulation as primarily shifting cost or supply conditions. From November 2008 to the enforcement date of January 2015, suppliers have about six years to either cease production in California or make the required adjustments to comply with new regulations. Over this time horizon, adjustments by producers in California would not be constrained by contractual relationships or fixed capital assets. Furthermore, prices of key inputs, feed and pullets, would not fall significantly as a result of falling California production because reductions in California production would be replaced by increases in production outside California. We expect a very elastic long run supply function among California producers because current fixed capital, primarily hen housing would be rendered obsolete and the egg industry in California is a relatively small buyer of other major inputs, including feed. As California output contracts, production outside of California would expand also with extremely elastic supply conditions. Marginal cost of production outside California would rise only marginally because, over this six year planning horizon there are no limiting factors given the moderate expansion expected in each local. The egg industry represents a small share of purchases of corn and soybeans. But, in any case, since total egg production would change little, only the location would shift, per unit cost of feed and other inputs would remain unchanged. Experience with the unexpected and rapid increase of egg shipments into California following the Exotic Newcastle Disease outbreak in 2003 illustrates the capacity for expanded production outside California, even in response to a short-run shock. With a six-year horizon, egg producing 18

19 facilities in the rest of the United States can easily increase production and expand shipments into California. Using the discussion above, we can assign approximate values to the elasticities and shifters in equation 6. The long run supply elasticity of California producers and the demand elasticity facing California egg production are both large. The shift in marginal cost is at least 20 percent and dlnb is near zero. If for example the long run demand elasticity is and the supply elasticity is 5.0. The percentage change in quantity produced from a 20 percent cost increase is -80 percent. Rather than pursue a more detailed analysis of this simple simulation approach the rest of this section illustrates the logic of the analysis in a simple supply and demand framework. Figure 3 corresponds to the equations just considered, but first let us explore the intuition of the approach with two alternative characterizations. Overall national consumer demand for eggs is relatively unresponsive to adjustments in market price. This means that small percentage increases in market prices for eggs would imply even smaller percentage reductions in quantities of eggs consumed. This inelastic demand response to price applies to overall table egg consumption and to shell eggs available to California consumers, which is the submarket in which most California-produced eggs are sold. Figure 1 illustrates the national market for table eggs, with California production shown explicitly as a share of national output and demand for eggs consumed in California incorporated within the national demand. For this illustration we assume that Proposition 2 has no effect on the demand for eggs in California or elsewhere. That is because the proposition is directed solely on how eggs are produced in California and not on the characteristics of eggs consumed, 19

20 the markets for non-cage and other specialty eggs are not affected and the overall demand function is also unaffected. [Place Figure 1 Approximately Here] The quantity of eggs produced in California before Proposition 2 takes effect is shown in figure 1 as the Initial Q, CA where the marginal cost of production in California equals the market price that is determined in the national market. The national supply is comprised of the (horizontal) sum of the supply produced in California and the supply produced in the rest of the United States (not shown separately). Notice that, in the figure, as in reality, California produces a relatively small share of the eggs in the national market. (For convenience figure 1 does not incorporate per unit transport costs of shipments into California.) The California regulations would cause an increase in marginal costs of production for California producers, which is shown as a shift to the New marginal cost/supply, CA. Data indicate that the increase in costs would be substantial, at least 20 percent or more. This shift is not calibrated precisely in figure 1, but the basic result is shown clearly. The quantity produced in California falls to zero, quantity produced outside California expands to fill the gap, and the national price and quantity of eggs either do not change or change so little that they cannot be illustrated in the figure without undue clutter. The main results hinge on the conditions of supply in the egg market, which are that: 1) California production is a relatively small share of the national supply; 2) the quantity of eggs produced outside California may be expanded with little or no marginal cost increase (supply function is very elastic in the long run); and 3) egg quantity reductions in California will not cause substantial declines in marginal costs of production in the state. Under these conditions, the figure illustrates the situation under which a substantial 20

21 increase in costs of production imposed on California production and not on production elsewhere will eliminate egg production in the state. As an alternative illustration of the main economic impact of Proposition 2, figure 2 depicts the market for fresh shell eggs sold in California, which is the sub-market of most importance to California producers. The figure illustrates the supply and demand considerations in this market before and after Proposition 2. In figure 2, the demand function represents only California consumers of shell eggs. On the supply side, most of the initial production is from eggs produced in California, shown as Initial Q, CA producers. The production of shell eggs shipped into California is implicit in figure 2 and makes up the difference between all shell eggs consumed in California and those shell eggs produced in California. The quantity shipped into California can be expanded readily should the California price rise above that shown by the intersection of the demand for shell eggs in California and the price of shell eggs. With these market conditions, a substantial increase in the marginal cost of production, up to the curve labeled New marginal cost/supply, CA producers, would cause production in California to fall to zero. Notice in this illustration that the price of shell eggs in California does not change. A slight increase in the price of shell eggs in the California market might occur if an increase in costs by national suppliers accompanied their expansion to replace eggs formerly produced in California. As noted above, we expect any such increase in price to be small because there are no limiting factors that would cause costs to rise for producers outside of California, given that they would have a six-year adjustment period before the regulations under the initiative would apply and California output would be curtailed. [Place Figure 2 Approximately Here] 21

22 As a final illustration we can consider specifically the market facing California egg production. In figure 3, the quantity on the horizontal axis is the production of eggs in California and the price is the price received by California producers. The supply functions for California producers are as represented in figures 1 and 2, but now the demand function represents the demand for eggs produced just in California. The residual demand facing California producers is very elastic because eggs produced outside California are almost perfect substitutes for eggs produced in California and the supply function for out-of-state eggs is very elastic. The model underlying figures 1 and 2 implicitly assumed, quite reasonably, that most consumers do not identify eggs according to where they are produced. However, in figure 3 we can allow eggs produced outside California to be close but less than perfect, substitutes for eggs produced in California. [Place Figure 3 Approximately Here] As before, the California regulations will cause an increase in marginal cost for eggs produced in California. Given a very elastic demand facing California production this shift up in the marginal function is enough to eliminate egg production in California. The exceptions are small specialized markets in which location is important to buyers or for which production costs do not rise because they are already using non-cage housing. California buyers currently purchase a relatively small quantity of specialty eggs from various non-cage systems that may meet the housing regulations implied by the initiative. This production would not be directly challenged by new regulations, but may be affected indirectly. Most of the eggs sold in the non-cage and organic markets are now produced by the same farms that supply the conventional egg markets that are illustrated above. We have established that this conventional production would be eliminated in California. Much of the infrastructure of feed 22

23 mills, cleaning and processing facilities and management expertise is used for both the non-cage and the conventional cage production systems. If conventional cage production is eliminated, firms may choose to move their whole operations out of state or may lose scale economies that make them competitive in the non-cage markets. Thus, we may expect a reduction in non-cage production in California, even though such production would comply with the law. Concluding remarks This paper has focused most of its attention to the production of eggs in California following implementation of Proposition 2. Outside of California producers would face an increase in demand of about seven percent to account for their opportunity to supply the remaining half of the California market that they do not now supply. We have ignored the potential competition from international imports. International imports are now very small and nothing in the housing rules in Proposition 2 would increase the competitiveness of international shipments into the United States relative to the current situation. We also do not devote significant discussion to the potentially expanding market for noncage specialty eggs. Nothing in the housing regulations indicated by Proposition 2 has a direct affect on the relative demand or the relative price of eggs from non-cage housing and conventional cage housing. It is possible that publicity surrounding Proposition 2 could itself shift out demand for non-cage eggs. We have not completed initial data analysis to test whether such a shift has occurred in However, since the new housing regulations are not scheduled to be implemented until 2015, the short run shifts in demand are not directly relevant. Our analysis shows that Proposition 2 in California, which mandated the elimination of conventional cage housing systems for egg production in California, will likely curtail egg production in California except for a very small residual of specialty producers that would supply 23

24 part of the market for eggs produced in non-cage systems and for buyers willing to pay a substantial premium for local production using conventional cage housing. This result follows from the long run supply and demand conditions that characterize the markets and specifically the ability of eggs produced out of state to compete effectively for demand from California buyers. 24

25 References Aerni, V., Brinkhof, M.W.G., Wechsler, B. and Oester, H. Productivity and mortality of laying hens in aviaries: a systematic review. World s Poultry Science Journal 61 (2005):142. Aho, P. W. (2002) Introduction to the US Chicken Meat Industry. Commercial chicken meat and egg production. D. Bell and W. Weaver, eds. Norwell, Mass.: Kluwer Academic Publishers, Appleby, M. C., B. Hughes, and A. Elson. Poultry Production Systems: Behavior, Management and Welfare. Wallingford, UK: CAB International, Bell, D. Twenty-five years in the Egg Business. An Egg Economics Update. April 7, Bell, D. Cage Management for Layers. Commercial chicken meat and egg production. D. Bell and W. Weaver, eds. Norwell, Mass.: Kluwer Academic Publishers, Bell, D. Egg Industry Statistics. Internet Site: Bell, D. Personal communication with Daniel A. Sumner, July Blokhuis, H.J. Personal communication with J.A. Mench. June California Health and Safety Code. Division 20, Chapter 13.8, Section California Health and Safety Code. Division 20, Chapter 13.8, Section 25991(f) Department of Agriculture, Fisheries and Forestry (DAFF). The Review of Layer Hen Housing, Canberra, Australia, European Food Safety Authority (EFSA). The welfare aspects of various systems of keeping laying hens. Opinion of the Scientific Panel on Animal Health and Welfare on a request from the Commission (Question N EFSA-Q ). The EFSA Journal 197(2005):

26 Elson, A. Do extensive poultry systems really offer superior welfare? Poultry International (March 2008): Foster, G. Personal communication with William Matthews, April Gibson, S.W., P. Dun and B. O. Hughes. The performance and behavior of laying fowls in a covered strawyard system. Research and Development in Agriculture 5, LayWel. Welfare implications of changes in production systems for laying hens. European Commission Sixth Framework Programme (FP6), European Research Programme, WP1-7 ( ). Marcus, B. Personal communication with Daniel A. Sumner, May Moark LLC. Internet site: (Accessed June 3, 2008). Rahn, A. P. Caged Laying Hen Well-Being: An Economic Perspective. Paper presented at the 52 nd North Central Avian Disease Conference and Symposium on The Science Behind Poultry Husbandry. Animal Health Diagnostic Laboratory and College of Veterinary Medicine, Michigan State University, Grand Rapids, MI, September 30, Rodenburg T.B., F.A.M. Tuyttens, K. De Reu, L. Herman, J. Zoons and B. Sonck. Welfare assessment of laying hens in furnished cages and non-cage systems Animal Welfare 17 (2008): Smith, D. K. An economic analysis of California egg supply and wholesale-retail price adjustments. Ph.D. dissertation. University of California, Davis, U. S. Department of Agriculture National Agricultural Statistics Service. Chickens and Eggs. Washington, DC U. S. Department of Agriculture National Agricultural Statistics Service. US Census of Agriculture. Washington, DC

27 Watt Poultry. Top Company Ratings. Egg Industry. 113(January 2007):4. 27

28 Table 1. Comparison of Production Costs Between Cage Production System and Non-cage Production System in Cost per Dozen Cage production system range and median ($ per dozen) Non-Cage production system range and median ($ per dozen) Cost Differential Non-Cage minus Cage System using mid-points Cost differential Non-Cage minus Cage System using low costs Pullets Feed Housing Labor Sum of the itemized costs and difference at the mid-points Sum of the itemized costs and differences at the low costs Percentage cost difference based on the sum of items Total Cost Percentage cost difference /0.595= 58% 0.20/0.45= 44% /0.745 = 0.40/0.57 = 70% 41% 1 Pullet cost is the original cost of the hen averaged over the hen s lifetime egg production. 2 Housing cost aggregates the cost of the housing structure, housing equipment, maintenance, service, supplies and utilities. 3 Labor cost represents only labor allocated to the layer house. 4 Total Cost constitutes a sum of the four cost categories plus additional costs such as overhead, taxes and miscellaneous costs, which are not listed separately. Source: Authors calculations based on data from California egg producers. 28

29 Figure 1 Market Effects of Layer Hen Housing Restrictions in California in the National Market for Eggs Price, marginal cost New marginal cost/supply, CA Demand U.S. Price Marginal cost/supply, CA Supply, US Initial Q, CA Q, U.S. Q, eggs in the U.S. 29

30 Figure 2 Market Effects of Layer Hen Housing Restrictions in California in the California Market for Eggs Price, marginal cost New marginal cost/supply, CA producers Price, shell Marginal cost, CA producers Demand shell eggs in Initial Q, CA Q shell eggs consumed, CA 30

31 Figure 3 Market Effects of Layer Hen Housing Restrictions in California in the Market for California-produced Eggs Price, marginal cost New marginal cost/supply, CA producers Price, CA shell eggs Marginal cost, CA producers Demand, CA produced shell Initial Q, California-produced shell eggs 31