Beer. You've seen it at sporting events, parties, and backyard barbecues, but have you ever thought about just what goes into that can or bottle? Not the ingredients, but economics. The brewing industry is quite complex, and it takes more than just brewing technique to get your favorite beer into your local store or bar.

Beer, like any good, follows the rules of supply and demand. If one of its ingredients, such as hops, gets more expensive, the price of the end product can go up. If grain prices skyrocket due to increased demand for grain-based ethanol to fuel vehicles, beer prices can go up as well. What makes beer unique is the way it reacts to different economic conditions, and how your government regulates it.

What Type of Good is Beer?

Is it a normal good, meaning that demand increases as incomes do? Is it an inferior good, meaning that demand decreases as does income (possibly because beer drinkers switch to wine)? Is it a luxury good, meaning that demand increases outstrip increases in income? That all depends, though research tends to support the idea that beer is a normal good. The beer industry is not homogeneous: there is a wide array of beer types available at different price points. This means that each segment of the overall beer market may react differently to economic cycles. Brewing as an industry, however, is often considered 'recession-proof.' For example, the stock of major beer-producing companies rose during the dotcom bust of the late 1990s.

The frothy stuff might not be considered by most to be a luxury good, but when it comes to the basics at the grocery store, it seems to almost fall into the 'can live without' category. So when money's tight, like it is during a recession, what happens to beer consumption? It turns out that recessions don't necessarily lead to a drop in demand; they lead to a different type of demand. Consumers switch from more expensive beer to the less expensive varieties, just like consumers switch from name-brand goods to the store-brand version. The consumption is there, but it's of the cheaper alternative.

Not only do recessions prompt consumers to switch from more expensive brews to more affordable ones; but new demand also comes from some unlikely sources: wine and liquor drinkers. When one considers the total market for alcohol-based products, wine and spirits traditionally sit on the more expensive end of the scale. Consumers still looking for a certain level of luxury in their alcohol purchases consider some beers as a viable alternative. One way in which brewers have tapped into this trend is by offering beers with higher alcohol content, and by emphasizing the exclusivity of craft beers. This is not dissimilar from what happens in any other industry, with suppliers creating new product offerings in order to meet burgeoning demand.

Beer Supply

The supply of beer has seen a number of changes in recent years, with increased production from traditional breweries, as well as the emergence of 'craft' breweries (those that use more traditional brewing ingredients and methods) and microbreweries (lower-volume producers). While the offerings of these two new types of breweries tend to be more expensive than traditional beers, this isn't necessarily because of prestige pricing. As is the general rule in economics, if demand for a certain beer is greater than the amount the brewer can pump out, prices will be higher. Larger brewers benefit from economies of scale; they are able to procure materials in bulk, have easier access to efficient transportation (beer available in more markets), and can produce a large volume of beer. This is a major reason for the lower prices of mass-produced beer as compared to the output of smaller breweries.

Why are more craft and microbrew beers coming to the market? A combination of regulation changes (President Jimmy Carter signed a bill making home brewing legal in 1979), post-Prohibition rebuilding (many brewers declared bankruptcy during the American Prohibition) and shifting consumer tastes have led to an increase in offerings in the beer universe (at the very least, its U.S. corner). Though craft, microbrew, and traditional beers may target different markets, the overall effect of a rise in the number of brewers is an increase in supply and an increase in competition.

Distribution and Regulation

The distribution of alcohol generally falls into a three-tiered system, which came about post-Prohibition. What is interesting about this system is that it requires all alcohol (there are a few exceptions) to pass through a middleman. The main reason for establishing the system in this way was to limit the ability of the producers, such as brewers, to own the two primary phases of the industry: production and retail. The fear was that if big producers controlled everything (like a Standard Oil of alcohol), then consumer choice would be limited, and everyone would be worse off. While this has worked to some extent, the regulation has created a number of headaches, and even a Supreme Court case (Granholm v Heald).

The three tiers of the system are as follows:

The top tier is comprised of the brewers who produce the beer.

The second tier is distribution. Producers will often provide exclusive rights to a certain company to distribute its product to different retailers, and the post-Prohibition landscape usually makes distributors powerful entities within each individual state. This reduces competition and can raise prices since fewer distributors mean less incentive to reduce prices. Some states have regulations further defining the relationship between the brewer and a distributor, even going as far as to bind a brewer to a distributor legally. This can create a headache for consumers since disputes between brewers and distributors can result in certain beers becoming unavailable in an area.

The third tier is retail. This is the point at which the general consumer can purchase the product, whether that be a grocery store, bar, or state-regulated vendor. As with many things, there is an exception: brewpubs – restaurants or pubs that produce beer on-site for sale on site.

A Unique Beverage

Beer, as well as other types of alcohol, is a unique beverage regulation-wise. Unlike that of carbonated beverages, fruit drinks, and almost any other beverage you can think of, the supply of beer is closely monitored by local, state, and federal governments, since it is considered a 'vice.' Municipalities regulate the sale of alcohol, either through state-sponsored stores, taxation, or other limitations, to raise funds or to control residents' access to alcohol. Political reasons aside, this can have a dramatic effect on the supply of beer, which in turn can increase its prices. Limiting the number of suppliers, such as grocery or convenience stores, effectively reduces competition, which in turn can increase the price of the good.

The Bottom Line

Whether you are relaxing at home, or out with friends, the beer in your hand is more than just liquid in a glass: it's a complex product shaped by supply and demand, production and distribution, with a whole lot of regulation thrown in for that extra kick.