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What does the 2009 bumper cherry crop reveal about the market for cherries (PART 2)?

This is the second part of a two part discussion. To read Part 1 go here.

Question 2: How low do cherry prices have to get for growers to not even bother picking the fruit, and when would someone decide to get out of growing cherries all together?

The economics of when firms shut down is an important topic in introductory economics courses because it includes some non-intuitive conclusions and requires applying a number of basic concepts.

Firms can either decide to shut down in the short run or the long run, and there is a precise delineation between these two within economics. The long run is a time period that would allow firms to make adjustments to inputs. For the case of cherries the long run is in large part determined by how long it takes to grow new trees.

The Short Run

A short run shut down decision for a cherry grower applies to the decision to harvest in a particular season since it is not possible to grow new trees or change inputs, such as water, that had to be done earlier in the growing season. The only decision left is to pick the fruit or not.

The cost associated with picking the fruit is referred to as a variable cost. Variable costs depend on decisions a firm makes about what activities to undertake. This differs from 'fixed costs' that are committed no matter what further operating decisions the firm makes. Fixed costs arise from things like investment in capital. Investing in the maintenance of a grove of cherry trees would be a fixed cost.

A cherry grower would decide to shut down in the short run if the average cost of picking the cherries (average variable cost) is greater than the market price for cherries. Based on the information in this article, when prices were $1 a pound for cherries a number of groweres decided not to pick. It is important to recognize also that the ability for packers to take in cherries could cause growers to not harvest. Critically, this does not mean that a firm will make a profit if they harvest because they still have fixed costs, but they will lose less money than if they had decided to not harvest.

This provides an explanation for what people often find to be counterintuitive. Namely, that operating firms often lose money in the short run. It is also important to recognize that the 'average' variable cost is used because the cost of harvesting each additional unit is different.

In 2009 a number of cherry growers in Washington shut down in the short run because they realized that the average cost of harvesting their crop was higher than the market price for cherries.

The Long Run

The important issue going forward for cherry growers in Washington following the 2009 season is whether any will decide to exit the market or reduce the capacity of their farm.

So when would a cherry grower decide to reduce their grove of cherry trees? First, if an industry is competitive then economic profit for firms in the long run will be zero (there is an important difference between accounting profit and economic profit). If it is not then other firms will enter the market, which happened with cherries in the Pacific NW in the last ten years resulting in a significant expansion in production capacity.

There will be neither exit nor entry if the price of cherries in the long run is equal to the marginal cost of producing the last cherry. In more technical parlance, the market is in equilibrium if marginal revenue is equal to marginal cost. If a grower believes that production has expanded to the point that prices will consistently be below their marginal cost of production then they are likely to exit.

While the goal of this piece was to demonstrate the economic concepts that were applicable to understanding the cherry market it was not possible to give a full explanation of each. A number of websites, and any introductory textbook, will give a more complete explanation of each term.