P=CYCLICAL PEAK: JULY 1953, JULY 1957, AND MAY 1960.

1/PREVIOUS PEAKS ARE NOVEMBER 1948, JULY 1953, JULY 1957, AND MAY 1960.

2/CYCLICAL TROUGHS ARE OCTOBER 1949, AUGUST 1954, APRIL 1958, AND FEBRUARY 1961.

NOTE. PERIODS COVERED ARE NOVEMBER 1948-AUGUST 1954, JULY 1953-APRIL 1958, JULY 1957-FEBRUARY 1961, AND MAY 1960-DECEMBER 1966 (LATEST DATA AVAILABLE).

SOURCES: DEPARTMENT OF COMMERCE AND BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM.

In summary, all major sectors of the economy experienced higher unit labor costs during 1966, particularly in the latter half of the year. This upswing broke a long record of relative stability. Productivity gains, which had been above trend during previous years, slowed down in 1965 and 1966 while the rise of compensation accelerated. The trend of prices, described in the following sections, could not be insulated from the resulting rise in unit costs.

PRICES IN MAJOR SECTORS

In view of the critical significance of prices in the 1966 economic record and in the outlook for 1967, a fuller review than usual of the price situation in major sectors is called for in this Annual Report. This review concentrates on four sectors: farm and food products; raw materials; manufactured products; and consumer services.

FARM PRODUCTS AND FOOD

As indicated earlier, farm prices rose sharply in 1965 and continued to rise during the first three quarters of 1966. Prices declined sharply in the final quarter of the year and by December showed little change from a year earlier. However, they remained well above the levels of early 1965. These increases were reflected at wholesale in the prices of processed foods, and at retail in the consumer price index.

The rise in farm prices was due to the strong expansion of domestic and export demand, combined with only slightly increased or in some cases reduced supplies of important farm commodities. Given adequate time for the adjustment of production, America's farmers are capable of expanding total farm output to meet any foreseeable expansion of domestic demand and to provide substantial surpluses for export, in most instances at essentially constant costs. To be sure, for some highly labor-intensive products— particularly dairy products and some fruits and vegetables-rising prices may be necessary to attract or hold the necessary labor services. But this is the exception rather than the rule. However, an expansion of farm output necessarily takes time-ranging from a few months for broilers, at least a year for most field crops, 1 or 2 years for hogs, and even longer for cattle or tree crops. To expand production of some of these commodities also requires changes in Federal farm programs.

Because of relatively long production cycles, supplies of some farm products reflect past rather than current prices. In 1965, hog supplies were declining in response to the low prices of 1963 and 1964. The resulting rise in livestock prices was intensified by strong consumer demand. The price rise which began in 1965 continued into early 1966. After February supplies began to expand, and by December wholesale livestock prices were 12.5 percent below the unusually high levels of December 1965.

Meanwhile, however, grain prices began to rise. At the beginning of 1966, grain prices stood 2.2 percent above their levels of a year earlier. During 1965, demand had expanded sharply but so had production. In 1966, strong domestic demand was supplemented by a jump in exports but total production was essentially unchanged from 1965 levels. Export demand was particularly buoyant for wheat, as reduced supplies from Argentina and Australia led to a rise in the volume of U.S. exports estimated at about 20 percent.

Prices for wheat, feed grains, and soybeans rose sharply during the late spring and summer. The rise was accentuated by speculation based on uncertain crop prospects and the strength of export demand. In the fall, harvests having proved somewhat better than had been expected, prices for grains and soybeans declined sharply. However, grain prices averaged 12.6 percent higher for December 1966 than a year earlier.

In contrast to both grain and livestock prices, dairy prices moved up sharply in the second half of 1966 as growing demands were matched with a decline in production. This decline in turn was related to general economic conditions as high beef prices induced farmers to cull and sell dairy cows while excellent off-farm employment opportunities encouraged some farmers to abandon dairying altogether.

Thus the major factors involved in rising farm product prices in 1966 were: (1) the hog production cycle which led to reduced marketings until mid1966 when numbers shipped began to increase;

(2) poor weather here and abroad which caused some decline in U.S. production and increased the demand for U.S. wheat exports;

(3) high cattle prices which resulted in reduction in dairy herds and good employment opportunities which induced farmers to leave dairying; √(4) strong demand for food based on rising consumer incomes.

1/FARM PRODUCTS INCLUDE DOMESTIC AND IMPORTED TEXTILE FIBERS, TOBACCO, AND SOME PRODUCE NOT SUBJECT TO PROCESSING.

SOURCE: DEPARTMENT OF LABOR.

Processed Foods and Foods at Retail

Changes in food prices at subsequent levels of processing and distribution generally follow changes in the costs of raw farm products. These costs, however, account for only about 40 percent of the price of delivered foods with the remainder reflecting costs of transportation, processing, distribution, and marketing. Over time these latter costs have risen steadily reflecting, in part, increases in labor costs and, in part, higher quality and better packaging. As a result, even when farm prices are stable, food prices, especially at retail, tend to rise.

Chart 10 shows the relation between farm and processed food prices and retail food prices. As expected, changes in farm product prices are more directly reflected in processed food prices. Changes in retail food prices tend to lag behind farm prices and fluctuate with less amplitude.

Following the decline in farm prices, processed food prices ended the year only slightly above the levels of December 1965. But retail prices remained 3.8 percent above the level a year earlier. The spread between farm and retail food prices narrowed during 1965, but then widened late in 1966. On the average, there is little evidence of an increase in processing and distribution margins. In the months ahead there may be some further decline in retail prices, but the rising trend in intermediate costs suggests that a full reversal cannot be expected.

RAW MATERIALS

The rise in raw materials prices which began in 1965 continued through 1966, although the prices of hides, secondary copper, and softwood lumber, which had risen rapidly during 1965 and early 1966, declined in the last half of the year. Prices rose for a wide range of mineral products, including sulphur, nickel, vanadium, and a number of other alloy metals. Some nonmineral raw materials used in industry-such as tobacco and woolalso rose.

Over long periods, the relative price of mineral products reflects a race between the improvement of the technology of discovery, mining, and refining and the gradual deterioration in the quality of available ores. Despite the fact that use is now made of ores which would have been discarded 30 years ago, the average price of minerals has not generally risen relative to other commodities.

In the short run, however, sharp increases in demand almost always mean higher prices for both ores and metals. Since it takes several years to develop new mines, increased requirements can only be met from inventories, and by stepping up output from existing capacity and from an expansion of capacity which is already under way. Once these limits are exceeded, as they have been for many of the minerals, pressures on price become severe. Even when primary producers do not raise their prices, or do not raise them enough to balance the market, secondary market prices will rise. The initial advance is likely to be accentuated by inventory speculation. Cor

respondingly, a relatively small improvement in the supply and demand balance can reverse the speculative movement and produce a sharp decline in price. These characteristics are shared by many nonmineral raw materials.

The upward pressure on raw materials prices in 1965 and 1966 reflected the slow response of supply to a sharp increase in demand. It was accentuated by the fact that the increase in demand was heavily concentrated in defense and capital goods which use large amounts of mineral raw materials. Random factors such as strikes and interruptions in foreign supplies always influence raw materials prices. Copper and hides were particularly affected by changes in foreign markets. However, in 1966 the strength of demand and the basically tight supply situation magnified the impact of fluctuations in supplies.

In the case of copper, strong demand drove domestic consumption up by more than 200,000 short tons from the first half of 1965 to the first half of 1966. Foreign supplies were reduced by strikes and political disturbances in the principal producing nations. While this loss was largely offset by sales from the government stockpile, prices in the United States were influenced by changes in the outlook for foreign supplies. The price of primary domestic copper was not raised significantly until early 1967, but the price in the secondary market, which supplies about one-third of domestic consumption, rose sharply to a peak of nearly $1.00 a pound early in 1966, compared with 36 cents for the primary refined metal. It then eased to a range of 50 to 60 cents during the summer and fall.

The influence of demand pressures was also clearly shown in the case of softwood lumber prices, which rose rapidly early in the year under the pressure of rising defense and construction demand, and then sank as residential construction declined.

As indicated below, the rise in raw material prices played a significant role in the increase in prices of manufactured products during 1966.

MANUFACTURED GOODS

In contrast to some farm products and raw materials, price changes in most manufacturing industries do not reflect an automatic balancing of supply with demand through the operation of impersonal market forces. Producers in many industries have some degree of discretion in setting prices, although the range of discretion varies with competitive conditions from industry to industry.

Firms with considerable market power are often able to maintain markups over unit costs that are largely independent of changing market conditions. In other industries, the effectiveness of market power is more limited. When utilization rates are low, markups often have to be shaded. By the same token, when demand and capacity utilization rates are high, competitive pressures are weakened, presenting the opportunity to restore temporarily depressed markups to desired levels or even to raise sights on