Estimation of Demand for Wheat by Classes for the United States and the European Union Samarendu Mohanty and E. Wesley F. Peterson This study estimates demand for wheat differentiated by classes using a dynamic AIDS model for the United States and the European Union (EU). The results suggest that imported wheat is more price responsive than domestic wheat in the U.S. market but not in the EU market. This may suggest that the Canadian policy that reduces prices of Canadian wheat in the U.S. market or U.S. export subsidies that raise prices of U.S, wheat could be expected to give rise to substmtial substitution of Canadian for U.S. wheat. It is also found that in the EU, complementary relationships exist between spring and other wheat groups, This complementary relationship between the lower and higher quality wheat in tbe EU is not surprising because EU millers blend cheaper wheat such as EU common wheat and U.S. other wheat with high protein (spring) to obtain the preferred characteristics. The world wheat market is one of the most widely estimated demand for wheat by allowing differen- studied commodity markets (McCalla; Alaouze, tiation both by country of origin and end uses. Watson, and Sturgess; Wilson, Koo, and Carter; The importance of product differentiation of and many others). Despite this interest, it remains wheat where trade is the focus has been recognized one of the most controversial commodity markets by Alston, Gray and Sumner, Both Larue, and Wil- because of its imperfectly competitive structure son (1989) argue that wheat should be differenti- (large grain trading companies and state import- ated both by country of origin and end use. Larue ers), product heterogeneity and the extensive gov- found that the assumption of one form of differen- ernment interventions in both exporting and im- tiation or the other would be appropriate if coun- porting countries. Among various aspects of the tries specialize in one product type and the given market, estimation of demand including export and product type is exported by only one country. In import demand has received significant attention in the case of wheat, this is not applicable because past decades. most countries trade more than one class of wheat. Most past studies estimating demand for wheat Sumner et al. point out that a single country would have either ignored or have failed to fully recog- not both import and export a commodity that is nize two important factors, product differentiation homogeneous except, perhaps, for some limited of wheat and the dynamics in wheat demand func- border trade. The existence of widespread intra- tions. With respect to product differentiation of industry trade in wheat is evidence that this prod- wheat, past studies can be divided into three dif- uct is differentiated in terms of origin, end use or ferent groups. First, many studies such as Konan- both. dreas, Bushnell and Green; and Gallagher et al. The importance of product differentiation of have assumed perfect substitutability across wheat is evident from recent interest among policy classes and origins. The second group of studies makers regarding bilateral trade flows of specific have allowed for imperfect substitutability either in classes of wheat. For example, the increased vol- terms of origin or end uses (Wang; Chai; Chang; ume of Canadian durum wheat exports to the and Agriculture Canada). Recently, Wilson (1994) United States in the early 1990s caused concerns among U.S, authorities, who argued that imports from Canada undermined U.S. price support pro- Mohantyisanassociatescientist at the Center for Agricultural and Rural Development at Iowa State University. Peterson is a professor with tJre grams. The U.S. government’s case for material Department of Agricultural Economics at the University of Nebraska- interference was primarily based on the fact that LhcOln. deficiency payments were determined by the do- Journal paper No. J- 1S053 of the Iowa Agriculture and Home Eco- nomics Experiment Station, Ames, Iowa, Project No. 3109, and sup- mestic market price of wheat and imports from ported by Hatch Act and State of Iowa funds, Canada increased the supply in the domestic mar- Mohan~ and Peterson Estimation of Demand for Wheat 159 ket and consequently reduced the market prices, case of several importers. This tends to freeze de- increasing deficiency payments (Sumner et al.) mand patterns in the short run because consump- The extent of the impact of Canadian wheat on the tion of final goods and technological capabilities U.S. domestic market, particularly prices, was ana- evolve fairly slowly so that there will be a ten- lyzed by USDA (1994) and Alston Gray and Sum- dency for limited responsiveness to short-run price ner using simulation models. variations. However, in a longer time frame, The USDA simulated the effects of reducing Ca- changes in final consumer demand and technologi- nadian exports to the United States of all types of cal innovation could lead to shifts in importer pref- wheat to half of base run values in 1993–94. Ac- erences as millers discover ways to blend or en- cording to Alston et al., USDA stated that it mod- hance cheaper wheats to obtain the desired char- eled a restriction of wheat grain imports to 261 kt acteristics at lower cost. Millers in the EU have (9.6 million bushels) without imposing any similar been able to concentrate protein and other desir- restriction on imports of flour and other wheat able attributes in their relatively low-qwdity wheat, products, but assuming they would be unaffected reducing the need to import North American wheat by a wheat import quota. Taking into account the for blending (Leuck). flour and wheat products, the USDA simulation Another important reason for a slow response to actually restricted total imports to 22.470 of the price changes might be long-term trade agreements base rather than 50%. Later, Alston estimated the (LTA) between an importer and an exporter. LTAs effects of Canadian imports by restricting Cana- typically involve shipment periods of two or more dian imports of each type of wheat to 22.4% of the seasons and often provide an upper and lower base to make their results comparable with those of bound on purchases (Harwood and Bailey). Thus, USDA. USDA reported an increase in average LTAs can decrease an importer’s flexibility to re- U.S. prices of 9 cents per bushel and a deficiency spond immediately to market conditions. LTAs are payment cost about $230 million lower, whereas widely used in world wheat trade (Harwood and Alston, Gray and Sumner found the U.S. price to Bailey). In the 1980s, approximately 25 to 30% of increase by only 0.008 cents per bushel with defi- world wheat was traded through LTAs (OECD). ciency payments $16 million lower. Such differ- The objective of this study is to estimate U.S. ences in results could be attributable to varying and European Union (EU) demand functions for assumptions regarding product differentiation of wheat taking into account both product differentia- wheat and demand and supply elasticities. USDA tion and functional forms. In both the EU and the appears to have aggregated all wheat types to- United States, multiple classes of domestic and im- gether, regardless of end uses and obtained quite ported wheat are consumed. For example, U.S. small elasticities of demand and supply, whereas wheat millers purchase different classes of domes- Alston, Gray and Sumner assumed product differ- tic wheat as well as two major types (western red entiation of wheat both by origin and end uses, spring and durum) imported from Canada. Simi- employing much larger demand elasticities esti- larly, in the EU, domestically produced soft wheat mated from a synthetic approach. Clearly, accurate (generally referred as common wheat) is consumed measures of demand function parameters are criti- along with various classes of wheat imported from cal for policy analysis. Canada and the United States. Clearly, the poten- In addition to product differentiation of wheat, tial for substitution of imports for domestic pro- the different specifications used in previous studies duction as well as between certain classes of wheat to represent wheat demand are static in nature. (e.g. hard red winter and hard spring wheats) may Static demand specifications are unlikely to cap- be of great importance for domestic market condi- ture the behavior of consuming regions because it tions and the realization of wheat policy objectives. takes time to adjust fully to any changes in market Thus, for example, a high degree of substitutability conditions, including price changes. Several fac- between U.S. and Canadian durum wheat means tors account for this slow adjustment on the part of that small price differentials could trigger substan- consuming regions. Habit formation can generate tial shifts in consumption patterns. On the other delayed responses (Pollak and Wales). This is par- hand, if U.S. and Canadian durum wheats are im- ticularly true for wheat because an importer’s pref- perfect substitutes, millers will find it more prof- erence for a specific class of wheat depends on its itable not to disrupt their purchasing procedures in end uses. This is supported by Wilson, Koo and the face of small price differences. In these circum- Carter, who found that importers are not indifferent stances, accurate estimates of the own- and cross- between wheat of different origins. They also con- price demand elasticities for various classes of cluded that there was limited or no switching be- wheat from different origins are essential for ef- tween wheat classes that are close substitutes in the fective and accurate policy analysis. 160 October 1999 Agricultural and Resource Economics Review It is our contention that more accurate estimates spect to aggregated wheat by Hennings and Martin.