BUFFER STOCK SCHEME ESSAY

MICROECONOMICS
[SAMPLE ASSESSMENT MATERIAL (H060/1)]
EVALUATE, USING AN APPROPRIATE DIAGRAM(S), THE EFFECTIVENESS OF A
BUFFER STOCK SYSTEM AS A METHOD FOR THE UNITED STATES GOVERNMENT
TO USE TO MAINTAIN STABILITY IN THE MARKET FOR WHEAT (20)
KNOWLEDGE (DEFINITIONS):

• A buffer stock scheme is a scheme intended to stabilise the price of a commodity by

buying excess supply in periods when supply is high, and selling when supply is low
APPLICATION / ANALYSIS:

• The US government may decide to use a buffer stock scheme to stabilise the price of
wheat because the uncertainty caused by the volatile prices is likely to deter agricultural
investment. The other aspect is that wheat may be seen as a necessity by the US
government, and so they may want to ensure that the price also doesn’t go too high, as
it could harm consumers. The US government can attempt to produce an optimum
outcome for both producers and consumers with a buffer stock scheme

• The graph on the left shows how the scheme deals with a glut (abundant) harvest. The
government believes that the socially optimal price of wheat is any price in the range
PMin to PMax, such as P*, for example. A glut harvest of wheat could cause supply to
increase from S to SGlut. Initially when supply increases, there is a surplus between E* and
E*2, but this is instantly resolved by the free market mechanism as the producers lower
their price until they have no excess stocks. This would cause the price to fall from P* to
PGlut with quantity increasing from Q* to QGlut. This is not thought to be a socially optimal
outcome in the US government’s eyes as the new price has fallen out of the optimal
range (PMin to PMax). The US government wouldn’t want this to happen, and so what they
do in this scheme is use tax revenue (or borrowed money) to purchase the surplus
stocks, causing demand to increase from D to D1, before the free market mechanism can
drop the price. The resulting effect is that price is brought back into the optimal range at
exactly the same price as before (P*) with a quantity of Q*2
• The graph on the right shows how the scheme deals with a poor harvest. A poor harvest
of wheat could cause supply to fall from S to SPoor. Initially when supply falls, there is a
shortage between E* and X, but this is instantly resolved by the free market mechanism
as the producers raise their price until there is no more excess demand. This would
cause the price to rise from P* to PPoor with quantity falling from Q* to QPoor. This is not
thought to be a socially optimal outcome in the US government’s eyes as the new price

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MICROECONOMICS
has risen out of the optimal range (PMin to PMax). Once again, the US government
wouldn’t want this to happen, and so they would take their reserve storages of wheat
and release them onto the market. This would cause supply to increase from SPoor back
to S, resulting in the previous optimum price of P* with quantity of the commodity at
level Q*.
• These workings of a buffer stock scheme show how the US government could maintain
stability in the market for wheat
EVALUATION:

• It must be noted, however, that there are potential hindrances to the effectiveness of a
buffer stock scheme, which may reduce its level of effectiveness for the US government
• The first reason as to why a buffer stock scheme may not be effective, is due to the fact
that it is virtually impossible to know the correct price. In many cases, what tends to
happen is that the price range the government tries to aim for is too high, and so they
find the price dropping out of the range more often than it rises out of the range. This
means that, in this case, the US government is likely to spend more of their time
purchasing wheat, rather than selling the wheat they would have been storing for so
long. This will result in this becoming a loss making endeavour, whereby they are
spending more tax revenue than they make back from the selling of the wheat they
stored. This is made worse by the fact that wheat is perishable. Given the fact that if the
government sets the price too high they won’t be using these stocks most of the time,
the government will indeed find themselves wasting and throwing away huge amounts
of produce which is highly wasteful, inefficient and very costly
• The second reason as to why the buffer stock scheme may not be effective is due to the
very high opportunity cost. Running a buffer stock scheme is extremely costly, often
costing billions of pounds. This is money that could have been spent on other essential
services such as health services, education, transport etc... Possibly, the US government
actually funded this through cuts in spending in these areas, and so they would be
creating new problems in said areas. Additionally, if the buffer stock scheme is paid for,
by the US government, through borrowing, the government will have to pay this back in
the future, and they may do this by raising taxes (to increase tax revenue). The higher
taxes could lead to demand for wheat falling, if there is a fall in average disposable
income, which would likely cause the price to fall out of the optimum price range. The
government would then need to spend more money to buy the surplus produce,
possibly leading the government into a cycle of indebtedness, whereby their debt just
continues to rise leading to further tax hikes in the future
• The final reason as to why a buffer stock scheme may not be effective is due to potential
abuse of the system. With a buffer stock scheme, the government is basically insuring
wheat producers against risk by saying that they will purchase any surplus produce. This
can lead to the market failure of moral hazard occurring, whereby commodity producers
don’t bother to control supply, resulting in the supply of said commodity increasing to
levels higher than it normally would. This is in fact made worse by the fact that some
wheat producers may go as far as to produce as much wheat as possible, with the
intention of making as much profit off of the government as possible, given the fact that
the government has guaranteed them that they will purchase any excess. This is
allocatively inefficient, and will likely lead to a large transfer of income (from taxpayers)
to some smaller percentage of society, a percentage of society who are not providing
any extra benefit to society, but are simply exploiting the government’s policy

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JUDGEMENT:
• Balancing both sides of the argument, the effectiveness of a buffer stock scheme as a
method of price stability, in the US wheat market, is likely to be very low. Price control
schemes require a great deal of management costs, and the methods of management
are extremely difficult to get right themselves. In an attempt to stabilise the wheat
market, the US government will suffer great cost (including opportunity cost) in doing
so, likely meaning that the cost of using a buffer stock scheme won’t be worth all of the
other potential problems it will cause. Furthermore, it could be argued that the
ineffectiveness of a buffer stock scheme in stabilising the wheat market, lies not only
with the flaws of the scheme, but in the fact that the US government would be trying to
stabilise a sector of the agricultural market, one of the most volatile markets in
existence. Essentially, it may have been a lost cause to begin with, and so the US
government would not stand a chance with a buffer stock scheme, or any other
potential schemes either

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