Economics of Buffer Stock Schemes

AS Economics

• Students should be able to apply the concept of government intervention in the form of buffer stocks that seeks to stabilise prices and incomes in agricultural markets
Any exam Q on price stability requires this theory

What is a buffer stock? • Many farmers of primary commodities face the problems of volatile prices and incomes • Buffer stock schemes seek to stabilise the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low .

Price volatility: Coffee World Coffee Price Monthly average composite price. Source: International Coffee Organisation 200 175 150 Describe the change in price over the 11 year period Is this a stable or unstable market? 125 USc/lb 100 75 50 25 95 What has been 96 the 97% change? 98 99 00 01 02 03 04 05 06 Source: Reuters EcoWin . US dollars per lb.

Price volatility: Copper World Price of Copper Spot price each day on the London Metal Exchange 9000 8000 7000 US dollars per tonne of copper Describe the change in price over the 4 year period Is this a stable or unstable market? 6000 5000 4000 3000 2000 1000 Jan Mar May Jul 03 Sep Nov Jan Mar May Jul 04 What has been the % change? Sep Nov Jan Mar May Jul 05 Sep Nov Jan Mar May Jul 06 Source: Reuters EcoWin .

Price volatility: Rubber World Rubber Price Daily closing price in the New York Exchanges. US cents per lb 140 130 120 110 100 90 USc/lbs Describe the change in price over the 6 year period Is this a stable or unstable market? 80 70 60 50 40 30 20 00 01 02 03 What has been the % change? 04 05 06 Source: Reuters EcoWin .

cotton or tobacco for the international markets is a hazardous business. • Commodity markets are characterised by instability and uncertainty.Commodities prices… • Producing commodities such as coffee. • This uncertainty may arise due to  fluctuations in the market prices due to market conditions changing  changes in prices due to changes in exchange rates  changes in foreign government protectionist measures .

Examples of buffer stock schemes • Cotton Price Stabilization Board • International Coffee Agreement • International Tin Council Coffee beans! .

Draw a Demand and Supply diagram for coffee commodity rather than starbucks! • Show a ‘shock’ to the market – what would happen if there was a coffee ‘mite’? • Show the immediate reaction? • How would ‘business’ consumers react? • How would the supplier react to this? • So what do you think might happen in the next season? .

Buffer Zone in diagrams .

Quantity Demand Q2 Q1 .Price support in a buffer stock Supply Price P min Pe • The government offers a guaranteed Price Floor minimum price (Guaranteed) (P min) to farmers of wheat. • The price floor is set above the normal free market equilibrium price.

then it must buy up the excess supply (Q2-Q1) and put these purchases into intervention storage.Price support in a buffer stock Supply Price P min Pe • If the government is to maintain the guaranteed Price Floor (Guaranteed) price at P min. Demand Quantity Q2 Q1 .

Price support in a buffer stock Supply Price P min Pe Price Floor (Guaranteed) Intervention purchases required to keep the price at Pmin Demand Q2 Q1 Quantity .

Price support in a buffer stock Supply Price P min Pe Total spending on intervention by the buffer stock = Pmin x (Q2-Q1) Price Floor (Guaranteed) Demand Q2 Q1 Quantity .

The government allows the market price paid by consumers to be freely determined by demand and supply. • Which area in the diagram represents the total subsidy payments made by the government to producers? Aw+y+z By+z Cx D x + y +z Answer: D . but guarantees producers a price of OP2.Question W02: • Q16 • The diagram shows the market supply and demand curves for a particular agricultural product.

the market supply of wheat will shift out putting downward pressure on the free market equilibrium price • In this situation.The effects of a rise in supply • Should there be a large rise in supply due to better than expected yields of wheat at harvest time. . the government will have to intervene once more in the market and buy up the surplus stock of wheat to prevent the price from falling.

Rising supply – more intervention Supply Price P min Pe S2 Price Floor (Guaranteed) How much would the ‘market buy? P2 How much would Govt buy? Demand Q2 Q1 Q3 Q4 Quantity .

Does it really work? .

Consider this diagram Max Min .

Your Q’s…. • What would happen is supply curve shifts between S2. S3 and S4? • What would happen if there was a supply shock to cause S5? • What would happen if there was a supply shock to cause S1? .

Consider this diagram Max Min .

The answers! • In the diagram shifts in the supply curve between S2. . • If the supply curve shifted to the left then the buffer stock authority would release stocks equal to Q1Q2 on to the market thus preventing the price rising to P4. • If a supply shock causes the supply curve to shift to the right to S5 then the buffer stock authority will intervene and purchase the surplus Q4-Q5 thus preventing the market clearing by itself through a lowering of the equilibrium market price to P1. S3 and S4 will only result in the price changing between the acceptable price band.

• How much of the product will the government have to supply from a buffer stock if demand is to be met? A OQ1 B Q1Q3 C Q1Q2 D Q2Q3 Answer: B. At P1. The government does not allow the price to rise above OP1. • Bad weather then reduces supply to S2S2. . there is a shortage of Q1Q3. S1S1 and DD represent the original supply and demand curves for an agricultural product.Question S03: 18 In the diagram.

What are the implications of each of these? .What can you do with surplus stock? • In the case where the surplus is bought there are number of options that can happen to the stock • It can be stored • It can be destroyed • It can be sold to other countries • It can be given as overseas assistance.

• Giving the food as aid could. . lead to a dependency culture. • Destroying surpluses especially if the surplus is a food is morally questionable in a world devastated by poverty and hunger. it is argued. • Selling to other countries at low prices or dumping can undermine domestic producers in the countries where the goods are sold.Implications of stock surplus… • Storage is expensive and involves an opportunity costs of the storage facilities.

• The success of a buffer stock scheme however ultimately depends on the ability of those managing a scheme to correctly estimate the average price of the product over a period of time . since money is needed to buy up the product when prices are low.Problems with buffer stocks • Setting up a buffer stock scheme requires a significant amount of start up capital. There are also high administrative and storage costs to be considered.

Problems with buffer stocks • If the target price is significantly above the correct average price then the organization will find itself buying more produce than it is selling and it will eventually run out of money • Conversely if the target price is too low then the organization will often find the price rising above the boundary. it will end up selling more than it is buying and will eventually run out of stocks .

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