The Farm-Retail Price Spread: The Case

of Postharvest Pesticides in Fresh

Grapefruit Packinghouses
Jean C. B w b y
John T Jones
John M. Love

This article uses marketing margin theory and
Gardner’s six equation model to estimate the impacts of
banning a postharvest pesticide from use in the fresh
grapejiruit industry. Spec$cally, the study calculated
four impacts of a postharvest pesticide ban: the impacts
are on the farm price, retail price, farm-retail price
ratio, and use of agricultural inputs for fresh
grapefruit. The percent of postharvest losses following
the ban is varied to determine the sensitivity of the cost
of the ban to the grapejiiuit industry and society as a
whole. 01994 by John Wiley 6i. Sons, Inc.
Traditionally, postharvest technology receives rela-
tively less attention than farm production technol-
ogy. Seminars, journal articles, and university
courses tend to focus on production. However,
postharvest technology is important in preventing
losses and diminished nutritional value. In devel-
oped countries, postharvest losses for horticulture
......................................................
Requests for reprints should be sent to J.C. Buzby, Economic
Research Service, US Department of Agriculture, Room 1108, 1301
New York Ave., NW, Washington, DC 20005.
crops range from 5 to 25%.l Therefore, in any
study of perishable commodities, postharvest
losses are important to consider. In this study,
postharvest costs and losses of fresh grapefruit
due to decay are considered as part of the cost of
marketing services. The study is important to the
economic literature because it illustrates the use-
fulness of marketing margin theory and Gardner’s
model in analyzing nontraditional research areas
and the results can be applied to similar market-
ing service cost increases in other industries.
This study addressed three main questions: if
grapefruit packinghouse costs increase: How does
the farm-level price change? How does the retail
price change? How does the retail-farm price ra-
tion change? The theoretical foundation presented
here portrays the likely impacts following in-
creased packinghouse costs on the farm level
price, retail level price, farm-retail price ratio,
and the use of agricultural inputs for fresh grape-
fruit. Specifically, the increased postharvest costs
are due to a hypothetical ban of a widely used
postharvest pesticide from use in the fresh grape-

...............................................................................................................
J.C. Buzby is Agricultural Economist in the Department of Agricultural Economics, University of Kentucky
stationed at the Economic Research Service.
J.T Jones is a PhD candidate in the Department of Economics, University of Kentucky.
J.M. Love is Agricultural Economist in the Economic Research Service, United States Department of Agriculture.
...............................................................................................................

Agribusiness, Vol. 10, No. 6, 521-528 (1994)

0 1994 by John Wdey & Sons, Inc. CCC 07424477/94/060521-08

0521
 Buzby, Jones, and Love
fruit packinghouses. The mandatory reregistration
of all chemicals by the Environmental Protection
Agency (EPA) makes such pesticide bans a possi-
bility. Despite a myriad of chemical and nonchem-
ical alternatives to any banned pesticide, invariably
these alternate technologies increase costs. Addi-
tionally, these costs may be compounded by higher
postharvest losses if the substitute technology is
inferior. Grapefruit packinghouses depend on fun-
gicides to maintain quality and there are only a
few postharvest pesticides available for grapefruit.
Both graphical and mathematical representations
are used to illustrate the effects of the hypotheti-
cal ban: marketing margin theory and Gardner’s
one-product, two-input model.
This article consists of three main sections: a dis-
cussion and graphical representation of the concept
of the marketing margin; the mathematical model;
and a sensitivity analysis on the effects of increased
postharvest pesticide costs. The sensitivity analysis
shows the effects of changing both the assumption
that inputs are used in fixed proportions and the
elasticity of the price of marketing services with re-
spect to a tax on marketing services.
Overview of the Grapefruit industry
Florida is the major producing state for fresh
market grapefruit. In the 1990 to 1991 season,
Florida, California, and Arizona produced 85, 12,
and 3% of total US production in tons, respec-
tively. Fresh grapefruit is a n important export
crop. In the 1989 to 1990 crop year, the United
States exported almost one-third of the 1742 mil-
lion lb of grapefruit produced.
Ward and Kilmer characterize the fresh citrus in-
dustry as individualistic, independent, and very
competitive.2 One part of the fresh grapefruit indus-
try includes the marketing service level that consists
of all activities beyond the farm-gate such as pro-
cessing, packaging, and transportation; marketing
services include fresh grapefruit packinghouses.
Theoretical Background
This section discusses the theoretical foundation
for representing the probable consequences follow-
0522
ing increased marketing service costs. Produce
losses are often considered only in terms of how
they affect retail price. Here, the implications of
packinghouse cost increases are estimated for
three marketing levels: the retail level, the mar-
keting service level, and the grove level. The
LL
grove” level targets the prices received by grape-
fruit growers. More commonly, other studies refer
to the “farm level.”
The marketing margin is defined as the vertical
difference between two prices from two different
marketing level^.^ The marketing margin (MM) is
equal to the difference between the retail price
(P,) and the farm level price ( P a ) ; (MM = P , -
P a ) . Tomek and Robinson” define the marketing
margin as the ‘‘price of a collection of marketing
services which is the outcome of the demand for
and supply of such services” and point out that
margins vary among products by the degree of
transportation, processing, and perishability of
the product. Traditionally, the marketing margin
is the difference between the retail level price and
the farm level price for a given quantity.
Marketing margin theory is complicated when the
identity of the good changes during the marketing
process. The margin’s measurement is more
straightforward in the case of fresh grapefruit
than for more complicated composite food prod-
ucts such as vegetable soup. Specifically, one fresh
grapefruit at the primary demand level (retail) re-
tains the same unit identity as one grapefruit at
the derived demand level (grove). Grapefruit at
the retail level has been enhanced by marketing
services, but the physical identity is unchanged.
There may be a relationship between the type of
margin and the cost structure facing the industry.
For example, if packinghouses face economies of
scale in providing marketing services, this could
lead to “negatively shaped supply curve(s) for
marketing services”; meaning that declining fixed
or percentage type marketing margins would be
expected for larger volumes of grapefruit mar-
keted.* One may expect that grapefruit packing-
houses have economies of scale due to high
packing line machinery (fixed) costs. The focus is
on costs and for simplicity, a fixed-absolute mar-
gin is incorporated here. Changes in marketing
service costs (i.e., marketing margin) are substan-
 Price Spread
tially more difficult to analyze than changes in ei-
ther the primary supply or primary demand.3 The
added difficulty is that both derived demand and
supply curves shift.
Marketing margins can change by the addition of
a new service in the packaginglmarketing stage
and changes in the existing packaginglmarketing
? s addition of a new service, all oth-
s e r ~ i c e s . ~The
er things held constant, tends to result in a retail
price increase; whereas, a change in existing ser-
vices tends to affect both retail and farm-level
prices." If grapefruit packinghouses switch to
more expensive pesticides, this substitution is a
change in existing services. The assumptions of
MM theory are:
1. the market structure of the industry is competi-
tive;
2. postharvest losses are incorporated in the cost of
marketing services";
3. the prices of all other inputs and outputs are
constant; and
4. inputs are always used in fixed proportions to
produce the final product (a = 0).
In reality, this partial-equilibrium analyses would
not occur as prices of substitutes changed." When
applying the standard MM assumptions to the
fresh grapefruit industry, changes in the level of
postharvest losses may not be fully incorporated.
Hence, in this study, there is some substitutability
between the agricultural and marketing service in-
puts (a > 0).
Graphical Representation of Increased
Packinghouse Costs
Consumers' purchasing behavior for fresh grape-
fruit represents the primary demand for grape-
fruit. Fresh grapefruit at the retail level is a
composite of grove-based and packaginglmarketing
components meaning that primary demand can be
thought of as a joint demand. When all the mar-
keting costs are subtracted from the primary de-
mand, the derived demand for the grove-based
components (i.e., untreated fresh grapefruit) can
be determined. The primary supply is the supply
of fresh grapefruit at the grove level and the de-
523
rived supply is the supply at the retail level after
the marketing services have been applied. The re-
tail price ( P x i )is determined by the intersection of
the derived supply and the primary demand. The
grove-level price (Psi) is determined by the inter-
section of the primary supply and the derived
grove-level demand. Essentially, the derived func-
tions represent how changes in the primary func-
tions are expressed to another marketing level.
An increase in packinghousetmarketing costs for
fresh grapefruit implies that the derived demand
and supply curves shift: the MM increases. Figure
1 shows the MM for the quantity of grapefruit (Xi)
as either the vertical difference between the prices
of the derived and primary demand, o r the verti-
cal difference between the prices of the derived
and primary supply. The graph assumes a fixed-
absolute MM meaning that the primary and de-
rived functions are parallel."
Based on anticipated activity, the MM is constant
for all levels of grapefruit marketed. The units of
grapefruit marketed are equivalent for both grove
and retail levels because postharvest losses are
subsumed in the cost of marketing services. In
Figure 1, the retail price ( P x l )at quantity (X,)is
determined by the intersection of the primary de-
mand and derived supply. The quantity of grape-
fruit (X,) and the grove level price ( P a l ) are
determined by the intersection of the derived de-
mand and grove level supply.
If postharvest pesticide costs increase substan-
tially, both derived functions are affected. Assum-
ing a fixed input production process, increased
marketing service costs will decrease the use of
both inputs. The retail supply decreases from SX
to SX' by the amount of the increased cost. The
grove level supply (primary) curve will not be af-
fected directly from the increased postharvest pes-
ticide cost because these pesticides are generally
not used in preharvest stages. However, the de-
creased use of marketing services indirectly affects
the use of agricultural inputs because of the fixed
proportionality of inputs: less grapefruit will be
produced and supplied to the retail market. In
summary, increased postharvest pesticide costs in-
creased the retail price, decreased the grove-level
price, increased the MM, and reduced the quan-
tity of fresh grapefruit marketed. The original
 Buzby, Jones, and Love
Price
MM2
x2x,
Figure 1. Shifts due to increased marketing costs.
marketing margin (MM1) increased by the amount
of the additional pesticide cost to MM2.
Although, MM graphs help portray the theory
behind the changes in the marketing costs, they
are difficult to operationalize. In this study, two
limitations of MM theory are the assumption that
inputs are used in fixed proportions (a = 0) and
postharvest losses are incorporated in the price of
marketing services. A mathematical representation
is necessary to obtain a firmer grasp on the effects
of the policy change and to observe the affects of
changing the assumption to where u > 0.
Mathematical Model Showing Effects
of Increased Packinghouse Costs
This section presents a mathematical model
illustrating the probable effects of an increase
in marketing service costs and provides im-
plications for grapefruit packinghouses, consu-
mers, and growers. Gardner’s7 one-product,
two-input model originally developed by Allen8
-524
SX’
SX Derived Supply
Derived Demand
Quantity of Fresh Grapefruit
and Hicks” is applied to the US fresh grapefruit
market.
The economic consequences of a hypothetical ban
of the widely used postharvest fungicide, sodium
o-phenylphenate (SOPP), from use on fresh
grapefruit were observed. SOPP has been found
to be carcinogenic and is currently in Stage IV of
the EPA’s reregistration process. The baseline is
the current status where the fungicide is available
for postharvest use on fresh grapefruit. Prior to
the Economic Research Services’ Postharvest Han-
dlers Survey of Florida’s fresh grapefruit packing-
houses, it was assumed that a SOPP ban would
force packinghouses to switch to more expensive
and perhaps less effective fungicides. The founda-
tion of this assumption is that most non-chemical
alternatives are more harmful than beneficial to
the fruit. Also, postharvest experts stressed the
importance and cost effectiveness of using SOPP
in grapefruit packinghouses. The survey found
that SOPP was widely used and that 29 out of 40
SOPP users would switch to a more expensive
postharvest pesticide if SOPP was banned.’ Strict
 Prlce Spread

legislation and low incentives for chemical compa- Equations (1) and (2) represent the supply and
nies to develop minor-use pesticides limit the alter- demand for fresh grapefruit at the retail level.
natives to SOPP. Equations (3) and (4) are the factor demand equa-
A SOPP ban may result in three main costs: new tions for a and b. The partial derivatives of the
equipment to apply the alternate pesticide; higher production function, Eq. (l),with respect to a
reoccurring expenditures for more expensive pesti- and b are the marginal products, f, and f,. Equa-
cides; and increased postharvest losses due to tions (5) and (6) are the supply equations for the
pathogen resistance. Although, SOPP costs make inputs a and b.
up a small portion of the value-added to fresh The exogenous change, T, represents a change in
grapefruit at the marketing service level, this mod- the cost of marketing services (i.e., Gardner's
el is important in indicating the likely direction of tax). T represents the increase in grapefruit
the grove-level and retail-level price changes fol- packinghouse costs resulting from a ban of SOPP.
lowing the ban. It is assumed that all grapefruit packinghouses are
The final grapefruit product ( x ) marketed in the affected equally. It is also assumed that there are
retail level is a product of two aggregated inputs: no substantial changes in the relative prices of
all land, labor, and capital inputs used at the other marketing inputs. Using Gardner's logic
grove level (a) and all land, labor, and capital in- applied to this study, this second assumption is
puts used at the marketing service level (b). The fairly realistic because: fresh grapefruit at grove-
output and both inputs have associated prices (P,, level a is a specific and necessary factor to the
P,, P,). Gardner's six endogenous variables (2, a, x industry, whereas b is unspecific to the x indus-
b , P,, P,,, P,) are adapted to the following six try; and fresh grapefruit production is land inten-
equations : sive. Therefore, it is likely that the own-price
elasticity of the supply of a is less than the own-
price elasticity of the supply of b. However, in a
long-run framework, it is possible that these two
x = D(P,) elasticities are equal for a crop such as grape-
fruit.
(3) In determining the effects of an increase in the
cost of T, the six equations were reduced to three
(4) equations (see Appendix). The following three
equations are the elasticities of the retail-level
(5) price, grove-level price, and output of fresh grape-
fruit with respect to a change in the cost of mar-
P , = h(a). (6) keting services:

where S, = relative share of a = aP,/P,; S, = ticity of the supply of a; eb = own price elasticity
relative share of b = bPb/P,; (T = elasticity of of the supply of b; eT = elasticity of Pb with re-
substitution between a and b; e, = own price elas- spect to T; q = price elasticity of demand for X ;

-525
 Buzby, Jones, and L o v e

E,T = elasticity of a with respect to T; EbT
elasticity of b with respect to T; and E x , = elastic-
ity of x with respect to T.
The first subscripted variable changes with a
change in the second subscripted variable. The
fourth elasticity of interest to this study, EtP,I,,,,)T,
was not directly obtainable because P , was can-
celed in reducing the six equations to three (see
Appendix).
where A = Sbea - Suen - u and B = -2ebS,She,
+ ebSfe, - uebSb + S2eueb - S,ue, - Sbe,T -
rlS,eb + uT.
Sensitivity Analysis
This section uses hypothetical parameter values to
examine possible implications of approximately
zero and positive elasticity of substitution and
varying sensitivity of Pb to a change in T(e,).
Love provided a price flexibility estimate for fresh
grapefruit (X) from data observed during periods
of drought.'" This flexibility (-0.66) is the inverse
of the own-price elasticity of the demand for X
used in the analysis. The sensitivity analysis con-
sisted of four cases; each case is sequentially rep-
resented by a row in Table I. The own-price
elasticities of supply (e,, e b ) are unitary. This is a
simplifying assumption and may closely represent
a long-run framework. The market shares (ScJ,S,)
are equal at 0.5.
We vary u between approximately zero and 0.5
to reflect varying substitutability of market level
services in the production of grapefruit. It could
be argued that zero represents low substitutability
and fixed proportions and 0.5 represents moder-
ate substitutability. More extreme substitutability
would be unlikely due the nature of the fresh
grapefruit industry.
We vary eT between approximately 0 and 1 to re-
flect varying sensitivity of the ban's effect on the
price of marketing services. eT = 0 would imply
that the pesticide ban would have very minor ef-
fects on the price of marketing services. Whereas,
eT = 1 implies that the ban would have a pro-
found effect on the price of marketing services.
Case 1 was where: the two aggregate inputs were
used in fixed proportions and the service sector
was sensitive to price ( e , = 1). Results showed
that the MM decreased when marketing costs in-
creased. The effect on P, is positive and equal to
the decrease in the MM. The elasticity of P , with
respect to T is 0: the consumers' price remains
unchanged. The effect of the change on the agri-
cultural inputs is zero so that the amount of
grapefruit at the grove level is the same.
Case 2 used the same u = 0 assumption as case 1
yet makes the price of the marketing services rela-
tively insensitive to the cost increase of marketing
services (eT = 0.05). Case 2 is similar to case 1 in
that E p x T % 0 meaning that the effect of eT is not
that great. Consistent with theory, E,T and EpXT
are not sensitive to the change in T. The first two
cases (where u = 0) indicate that growers absorb
almost all of the shock.
Case 3 relaxed the u = 0 assumption and com-

~ ~ ~ ~ ~~~~~~~~

Table 1. Elasticities of P,lPd, a, PI, and Pa with Respect to Shifts in Marketing Supply Input.
............................................................................................................
(T eT $rna,T EV,T &T
............................................................................................................
Case 1 0.0001 1 -0.5 0.5 0 0
Case 2 0.0001 0.05 -0.025 0.025 0 0.025
Case 3 0.5 1 2 -0.5 1.5 -0.5
Case 4 0.5 0.05 0.1 -0.025 0.075 -0.025
In all four cases, e, = 1, e,, = 1, 9 = -0.66, and S, = 0.5.

526
 Prlee Spread
bined it with a relatively strong elp With these two
effects, one would expect that the industry would
substitute away from b to the relatively cheaper
input a. The analysis shows that this is not so.
The use of agricultural services decreased by as
much as its price increased. Out of all four cases,
this case showed the largest effects. The MM in-
creased and the consumers’ increased price re-
flected most of the change of the increased costs of
postharvest pesticides.
Case 4 also relaxed the u 2 0 assumption and
this assumption was combined with a relatively
weak e T . The effects are similar to case 3, only
reduced in magnitude by the weaker e T .
Conclusions
In summary, both the MM concept and Gardner’s
six equation model can be applied to represent
changes in packinghouse costs that ultimately af-
fect consumers, grapefruit producers, and pack-
inghouses. Specifically, both the graphical and
mathematical sections of this article showed how
the increase in the cost of marketing services can
be transmitted to affect the retail price, grove lev-
el price, grapefruit supply, and the retail-grove
price ratio for the fresh grapefruit industry.
Case 2 most closely approximates reality because
the elasticity of substitution between inputs is
small and even a significant increase in the cost of
postharvest pesticides will not affect P , greatly.
The results of case 2 follow theory in that there is
a small amount of substitution away from b to a:
all of the shock is absorbed by farmers; and the
retail-grove price ratio decreased.
The sensitivity analysis also showed that only in
References
1. Adel A. Kader, ed. Postharvest Technology of Horticul-
ture Crops, Univ. of California, Division of Ag. and Nat.
Resources, Oakland, Publication 3311, 1992.
2. Ronald W. Ward and Richard L. Kilmer, The Citrus
Industry: A Domestic and International Economic Per-
spective, 1st ed., Iowa State University, Ames, IA,
1989.
3. Richard L. Kohls and Joseph N. Uhl, Marketing of Agri-
527
cases 3 and 4 will consumers be relatively more af-
fected than growers. Case 3 presents a surprising
result; allowing for input substitution, there was
no substitution.
Overall supply of fresh grapefruit will be re-
duced to an extent dependent on the magnitude of
the pesticide cost increase, the sensitivity of P, to
T, and the limitations of the alternative pesticide
in maintaining quality during export. The ability
of any alternative pesticide to SOPP in maintain-
ing quality is crucial because exports constitute
one-third of the total quantity of US grapefruit
produced and a limited variety of pesticides is
more likely to promote resistant strains of fungi.
In the long run, increased pathogen resistance to a
narrower selection of pesticides will increase post-
harvest losses to some unknown extent. To date, it
has not been estimated how severely a switch to an
alternative pesticide will affect grapefruit exports.
Some import policies restrict the importation of
produce treated with certain chemicals. Future re-
search could explore the effects of switching to al-
ternative pesticides on grapefruit supply, hence on
exports. Two additional equations incorporating
the international supply and demand for fresh ex-
ports could be added to the framework provided
here.
In short, packinghouses may potentially be af-
fected by increased postharvest losses, higher
chemical costs, and a decreased demand for the
safer, yet more expensive grapefruit. However,
grapefruit packinghouses will not be as affected by
the ban as growers who still absorb most of the
price shock. This implies that grapefruit growers
have a vested interest in any policy that bans a
postharvest pesticide that is widely used in grape-
fruit packinghouses.
cultural Products, 7th ed., Macmillan Publishing Co.,
Inc., New York, 1990.
4. William G. Tomek and Kenneth L. Robinson, Agri-
cultural Product Prices, 2nd ed., Cornell University
Press, Ithaca, NY, 1972.
5. B.S. Fisher, “The Impact of Changing Marketing Margins
on Farm Prices,’’ American Journal of Agricultural Eco-
nomics, 63, 261 (1981).
 Buzby, Jones, and Love
6. William M. Snell, Personal Communication, Dept.
of Ag. Econ., University of Kentucky, November
1992.
7. Bruce L. Gardner, "The Farm-Retail Price Spread in a
Competitive Food Industry," American Journal of Agri-
cultural Economics, 57 (1975).
8. R.G.D. Allen, Mathematical Analysis f o r Economists,
Macmillan & Co., London, 1938.
Appendix
In determining the effects of an increase in the cost of
marketing services ( T ) , Eqs. (1)-(6) were differentiated
with respect to T. The six new equations were then
reduced to three equations by setting pairs of supply
and demand equations equal for each input and out-
put. In the process, x, Pa, and P b were eliminated.
Equation (7) represents the market equilibrium
for x. Equation (8) represents the market equilib-
rium for a. Equation (9) represents the market
equilibrium for b .
da da db dP
ha - = Pxfaa - + P f - + f a 2 (A2)
dT dT ab d T dT
After manipulating the above equations and obtaining
elasticity terms, a system of three elasticity equations
528
9. J.R. Hicks, The Theory of Wages, Peter Smith, Glouces-
ter, MA, 1957.
10. John M. Love, unpublished work on price flexibilities of
fresh grapefruit, Fall 1992.
11. Bruce W. Char, Keith 0. Geddos, Gaston Gonet. Benton
L. Leong, Michael Monagan, and Stephen M. Watt, MA-
PLE V Library Reference Manual, Springer-Verlag, New
York, 1991.
was produced, one for each input and one for the out-
put. Equation (10) represents the market for x, Eq.
(11) for a , and Eq. (12) for 6 .
')
e T = -'aE a T -
U
(- - f
eb
EbT Epx,. (A6)
The effects on P,, P , , and a with respect to a change
in T were found by simultaneously solving the three
elasticity equations with the computer program,
MAPLE." The elasticities of the retail-level price,
grove-level price, and output of fresh grapefruit with
respect to T are E p , T , E p a T , and E a , T provided in
the text. The fourth elasticity was obtained using
Eq. (A7).