How Replacement Cost Affects Food Price Adjustment

Corporate pricing decisions are not determined solely by historical acquisition costs.

After selling existing inventory, firms must re-enter the market to replenish those goods. The cost required to acquire them again is known as the replacement cost.

Pricing decisions therefore, depend less on:

• How much the goods were originally purchased for
  and more on:

• How much will it cost to replenish them next?

This forward-looking perspective is closely related to the concept of opportunity cost.
The price at which firms choose to sell current inventory is rationally influenced by the price at which they expect to reacquire it once it is sold.

Why Food Prices Rise Faster When Oil Prices Increase

Consider a situation in which oil prices surge rapidly.

• Existing inventory may have been acquired at lower cost levels.

• However, the next round of procurement is expected to occur at much higher prices.

If firms continue selling at the old lower prices, profit margins would deteriorate sharply when they replenish inventory at higher costs.

As a result, firms tend to incorporate expected future costs into current prices.

This helps explain why prices often rise relatively quickly during periods of cost increases.

Why Food Prices Fall More Slowly When Oil Prices Decline

Now consider the opposite scenario: oil prices decline.

• Existing inventory may have been acquired at high cost levels.

• However, future procurement is expected to be cheaper.

If firms immediately cut prices sharply, inventory losses would be realized.

Instead, firms typically attempt to liquidate existing stock at current price levels before adjusting downward.

Consequently, price declines often occur gradually rather than immediately.

Price Asymmetry in Energy and Food Markets

Importantly, this is not merely the behavior of an individual firm. It represents the aggregation of rational decisions across market participants.

Several mechanisms reinforce this pattern:

• Many firms consider replacement costs in pricing decisions.

• Contracts and pricing agreements cannot be adjusted instantly.

• Retail markets face menu costs (the costs of changing prices).

When combined, these factors may produce a pattern in which:

• Prices rise quickly during cost increases,

• But decline more slowly during cost decreases.

In economics, this phenomenon is referred to as price asymmetry.

What Has (and Has Not) Been Empirically Verified

However, this remains a theoretical hypothesis.

So far in this series, we have confirmed:

• A strong same-month co-movement between oil and cereal prices

• An estimated elasticity of β ≈ 0.27

• A maximum correlation at lag = 0

We have not yet statistically tested whether adjustment speeds differ between rising and falling price phases.

Therefore, what is presented here is a plausible mechanism, not an empirically verified conclusion.

How Inventory Affects Food Price Adjustment (Not Direction)

From the previous analysis, the following findings are confirmed:

• Oil prices and cereal prices move strongly together in the same month (r ≈ 0.833).

• The maximum lag in cross-correlation is at most one month.

These results suggest that the direction of price movements — whether up or down — is transmitted relatively quickly.

In other words, a shock in the energy market is reflected in the cereal market within roughly one month.

Importantly, this implies that inventory is unlikely to determine the direction of price movements.

Direction appears to be driven primarily by:

• Energy prices

• Broader macroeconomic conditions

• Supply and demand shocks

Inventory Influences the Speed and Magnitude of Price Adjustment

If inventory does not determine direction, what does it affect?

Inventory likely influences:

• The amplitude of price movements (how much prices move)

• The persistence of price levels (how long they remain elevated or depressed)

• The speed and smoothness of adjustment

For example:

• When inventory levels are low, even small supply shocks can tighten the market quickly, leading to sharp price increases.

• When inventory levels are high, similar shocks can be absorbed, resulting in more gradual price adjustments.

In this sense, inventory may not create a “delay” in price transmission.
Rather, it functions as a buffer that moderates the magnitude and persistence of price movements.

This interpretation is more consistent with the empirical findings so far.

Evidence from Lag Structure

If inventory were the primary determinant of price direction, we would expect the maximum correlation to occur at longer lags.

However, the strongest correlation is observed in the same month (lag = 0).

This suggests that inventory does not drive directional changes in prices.

Instead, it may influence the quality of adjustment — how strongly and how persistently prices react after a shock.

A Three-Layer Model of Energy, Inventory, and Food Prices (Hypothesis)

Bringing the analysis together, a structural hypothesis begins to emerge.

1. Energy prices generate cost shocks.

2. Inventory levels amplify or dampen the strength of price movements.

3. Market expectations influence the persistence of price adjustments.

In simplified terms:

• Energy is the origin of the shock.

• Inventory acts as a buffering layer that adjusts its intensity.

From the empirical results confirmed so far:

• Oil and cereal prices move strongly together in the same month.

• The maximum lag is at most one month.

• The estimated price elasticity is approximately 0.27.

These findings suggest that the direction of the shock is transmitted quickly across markets.

What Energy Prices Do Not Fully Explain

However, while energy prices explain the direction of movement, they do not fully account for:

• How large the price movement becomes (amplitude)

• How long the elevated or depressed price level persists (persistence)

The magnitude and duration of price adjustments cannot be explained by energy prices alone.

This unexplained component may be where inventory plays a structural role.

At this stage, however, no quantitative testing of the relationship between inventory levels and price volatility has yet been conducted.

The Position of This Article in the Research Framework

This article represents the first empirical stage of the series.

So far, we have confirmed:

• A strong co-movement between energy and cereal prices

• A measurable price elasticity

• A lag structure indicating rapid transmission

However, several hypotheses remain untested:

• Do inventory levels affect the speed of price adjustment?

• Is there asymmetry between rising and falling price phases?

• Does inventory modify the energy price elasticity?

These questions are necessary to understand the dynamic structure of inflation and commodity price transmission.

Next Step — Testing the Inventory–Price Interaction

The next stage moves from theoretical organization to empirical verification.

Specifically, we will examine:

• A simple regression between inventory ratios and price movements

• Elasticity comparisons across high- and low-inventory regimes

• An interaction model between energy prices and inventory levels

These approaches will allow us to test whether inventory functions as a structural moderator in price transmission.

Conclusion — What We Can and Cannot Say

At this point, the following can be stated with confidence:

• The direction of price movements between oil and food markets is transmitted quickly.

• The amplitude and persistence of price changes may depend on additional structural factors.

It is possible that inventory does not determine the direction of price movements, but rather influences the speed and magnitude of adjustment.

However, price asymmetry has not yet been empirically verified in this series.

The current results provide structural implications — not definitive proof.

Whether this hypothesis holds will be determined in the next stage of data-driven analysis.

▶ Does the inventory ratio change price sensitivity? (Next article)