Giannini Foundation of Agricultural Economics

This report describes an economic study of the California avocado industry, including its economic history and markets, and presents an econometric model of supply, demand, and price. The objective of this study is to determine the effect of California avocado industry advertising and promotion expenditures on the demand and price for California avocados and to estimate the ratio of benefits to costs for marketing programs conducted by the California Avocado Commission. The econometric model used to evaluate the impact of industry advertising and promotion includes components for avocado supply, demand and equilibrium price. Following is a description of study results for each of the major components.

Avocado Supply: The two major determinants of annual avocado production, average yields and bearing acreage, are examined in some detail. Average yields, which are responsible for sharp year-to-year variations in total production, have become increasingly variable over time. While yields demonstrated a rather steady upward trend from 1926 through 1956, there was little, if any, trend evident after 1957. Possible explanations for termination of the upward trend in yields and increased variability include expansion of new acreage on land not ideally suited to avocado production because of climate, soil quality or topography, and reduced water use due to sharp increases in water costs in major production areas.

Avocado acreage changes annually as producers make decisions on whether to plant new trees or remove existing trees. These decisions are hypothesized to be based on expected profits over the bearing life of new trees or the remaining life of existing trees. Proxies for expectations based on recent prices, costs and total returns, which have performed well in other studies, were used to explain plantings, removals and annual adjustments in both bearing acreage and total acreage. Avocado acreage response equations found (1) that plantings increase with increases in recent average returns per acre adjusted for costs, (2) that favorable income tax provisions for development of groves led to increased plantings, and (3) that sharply increased water costs were correlated with reduced plantings from 1990-91 through 1994-95. Removals of avocado trees tended to respond most to the immediate past year’s costs and prices. The plantings and removal relationships were combined in an estimated equation for the annual change in bearing acreage which was used to represent annual acreage response for California avocados in the simulation analysis described below.

The Demand for Avocados: California avocado prices and quantities trended upward over the period considered (1962-95). However, in real terms, prices varied substantially around a slightly downward trend. At the same time, gross producer revenues trended upward in both nominal and real terms, indicating that growth in quantity more than offset the decline in real prices. Overall, there has been significant growth in the demand for avocados over time. Factors associated with this growth in demand are examined in some detail using (1) an annual analysis of demand for the period 1962 through 1995, and (2) a monthly analysis of demand for the nine marketing years 1986-87 through 1994-95

Annual Demand: An annual econometric model of the demand for California avocados, with annual average farm level real price per pound specified as the dependent variable, was specified and estimated. The preferred econometric model, which was selected on the basis of statistical tests and economic theory, shows that the quantity of avocados offered on the market is a very important explanatory factor, having a strong, negative impact on price. The estimated price flexibility of demand of -1.33 (at the average values for each of the variables) means that a one-percent increase in quantity supplied will cause a 1.33 percent decrease in price, and a .33 percent reduction in gross revenue, other factors constant. Demand is quite inelastic, as indicated by year-to-year changes in production and total crop revenues. Surprisingly, the quantity of Florida avocados sold was found to have a positive effect on California prices but, statistically, this effect was not significantly different from zero. Avocado imports were found to have a relatively large, and statistically significant, negative impact on California avocado demand and prices. Real per capita disposable income was found to have a large, and statistically significant, positive impact on avocado demand and prices, confirming that avocados are a normal good and that an increase in consumer income leads to a more-than-proportionate increase in demand.

The annual econometric model indicates that advertising and promotion had a positive impact on California avocado demand and prices, and the point estimate shows a price response of plausible magnitude (the estimated price flexibility is 0.13, indicating that a one percent increase in advertising and promotion expenditures leads to a 0.13 percent increase in price, holding quantity constant). The estimated effect of advertising and promotion, which is not statistically significant at the usual 95 percent level, is significant at the 86 percent level. This lack of precision for the advertising variable may be the result of data problems and other factors. These include mismatches between the California and Florida crop years that we were unable to correct (and probably resulted in the unexpected positive relationship between Florida sales and California prices), the changing year-to-year activities included in the advertising variable, and possible structural changes. A monthly analysis of demand for California avocados was undertaken as a partial solution to limitations evident in the annual analysis.

Monthly Demand: The model of monthly demand for California avocados was patterned after the annual demand model. Average f.o.b. level monthly real price per pound was specified as a function of pounds of avocados shipped from California and Florida, imports, consumer income, CAC marketing expenditures, brand advertising and promotion, prices of related goods, and monthly demand shifters. Initial testing resulted in deleting several variables from the analysis, including the prices of possible related products and brand advertising expenditures by California avocado packers. None was statistically significant (t-ratios were very small) in any of the formulations tested and it was concluded that these variables have had no statistical effect on the monthly demand for all California avocados. The use of monthly data permitted close matching of avocado sales from all sources, avoided potential problems of structural change, and provided the best available data on advertising and promotion expenditures.

Results of estimating the monthly demand for all California avocados were in line with expectations and were a definite improvement over the annual model. Each of the variables had the expected sign (Florida sales had a negative impact on California prices), most were statistically significant, and the magnitude of the estimates was reasonable. Advertising and promotion expenditures had a statistically significant positive effect on the price of (and demand for) California avocados. The monthly and annual price flexibilities of demand with respect to advertising and promotion were almost identical (0.137 for the monthly analysis vs. 0.130 for the annual analysis). Advertising and promotion also had estimated lagged impacts on California avocado prices and demand that extended five months after the month the expenditures were paid. The estimated price flexibility of demand of -1.54 is larger than the annual estimate of -1.33, but the monthly quantity variable includes both California and Florida sales. The demand for California avocados at average prices and quantities is inelastic at both the farm and f.o.b. levels, whether measured on an annual or monthly basis. This means that total industry revenues will be less for a large crop than for a small crop.

Estimated Benefit-Cost Ratios for Advertising: Measurement of benefits and costs for commodity advertising are not as simple and straight-forward as they first appear. Depending on assumptions, there are different measures of benefits, including average and marginal benefits measured in the short run (assuming fixed supply) or in the long run (after adjustment of acreage to price changes). For this study, fixed supply benefits were estimated both annually and monthly. The time horizon also affects the measurement of costs. In the short run, all costs of advertising and promotion are paid by avocado producers. However, in the long run, producer adjustments to the assessments used to fund advertising and promotion act as a tax, which producers are able to partially shift to buyers. Following are the range of benefit-cost ratios estimated in the study.

The annual fixed supply industry returns from CAC advertising and promotion expenditures ranged from a weighted average of $5.33 to $6.01 per dollar spent depending on the time period examined and the discount rate used (note that all returns are total returns before the deduction of advertising expenditures). A simple average of the annual fixed supply benefit-cost ratios is equal to 5.25. Short term returns for the most recent nine years (1986-87 through 1994-95 marketing years), based on the monthly analysis and discounted at 3 percent, yields a weighted average return of $6.35 per dollar spent on advertising and promotion. For the nine-year period of analysis, the monthly marginal and average benefit-cost ratios are equal to 8.92. The marginal benefit-cost ratios were greater than one for all but two months of the period, indicating that the CAC could have profitably increased advertising and promotion during all but two months of the nine-year period.

These returns are eroded over time, however, when the acreage response to higher returns is factored into the analysis. Producers make decisions in response to higher returns that result in expanded acreage, but there is a lag of several years before production increases. Because demand is inelastic, increased production decreases both price and total revenue and production response may partially or totally offset increased demand due to advertising. The annual simulation model was run with actual and zero advertising and promotion expenditures and the annual difference in total industry revenues was compared to advertising and promotion expenditures. CAC marketing program expenditures increased estimated net total industry revenues by $102.8 million over the period of analysis. In other words, estimated net industry total revenues after deduction of advertising and promotion expenditures would have been $102.8 million lower than actually occurred, and the industry would have been smaller, had the CAC not been conducting its advertising and promotion programs. When real costs and returns were discounted at 0 and 3 percent, the overall long-run discounted real returns from advertising and promotion were $1.78 and $1.71 per dollar spent, if producers paid the total costs of the program. After accounting for costs shifted to buyers, we estimated that California avocado producers enjoyed an annual average benefit-cost ratio of 2.84 for the 34-years of the analysis. The long-run weighted average benefit-cost ratios, when costs and returns are discounted at 0 and 3 percent, are 2.48 and 2.26, respectively.

On a month-to-month and year-to-year basis, the industry has realized excellent returns from generic advertising and promotion programs. Over time, however, the supply response resulting from increased returns can erode prices and net returns. As illustrated, avocados tend to exhibit cycles of production and prices; attractive returns from advertising can contribute to these cycles. This is the nature of the short-run versus the long-run returns to advertising when the industry does not control supply and there is ease of entry and exit. Nevertheless, generic avocado advertising and promotion has provided excellent producer returns in both the short run and the long run.