Economics of Buffer Stock Schemes

AS Economics

BUFFER STOCKS SCHEME

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, US dollars per lb. 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

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

Commodities prices
Producing commodities such as coffee, cotton or tobacco for the international markets is a hazardous business. Commodity markets are characterised by instability and uncertainty. 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

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.
Quantity

Demand Q2 Q1

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, then it must buy up the excess supply (Q2-Q1) and put these purchases into intervention storage.
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

Question W02:
Q16 The diagram shows the market supply and demand curves for a particular agricultural product. The government allows the market price paid by consumers to be freely determined by demand and supply, but guarantees producers a price of OP2. 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

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 market supply of wheat will shift out putting downward pressure on the free market equilibrium price In this situation, 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 Qs.
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, S3 and S4 will only result in the price changing between the acceptable price band.

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.
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.

Question S03:
18 In the diagram, S1S1 and DD represent the original supply and demand curves for an agricultural product. Bad weather then reduces supply to S2S2. The government does not allow the price to rise above OP1. 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, there is a shortage of Q1Q3.

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.
What are the implications of each of these?

Implications of stock surplus

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

Problems with buffer stocks

Setting up a buffer stock scheme requires a significant amount of start up capital, since money is needed to buy up the product when prices are low. There are also high administrative and storage costs to be considered. 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

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