Economics of Buffer Stock Schemes

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Economics of Buffer Stock Schemes

• AS Economics

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Syllabus Requirements

• Buffer Stocks
• 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
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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

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Price volatility Coffee
Describe the change in price over the 11 year
period
Is this a stable or unstable market?
What has been the change?
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Price volatility Copper
Describe the change in price over the 4 year
period
Is this a stable or unstable market?
What has been the change?
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Price volatility Rubber
Describe the change in price over the 6 year
period
Is this a stable or unstable market?
What has been the change?
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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

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Examples of buffer stock schemes

• Cotton Price Stabilization Board
• International Coffee Agreement
• International Tin Council

Coffee beans!
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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?

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Buffer Zone

• in diagrams

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Price support in a buffer stock

• The government offers a guaranteed minimum price
  (P min) to farmers of wheat.
• The price floor is set above the normal free
  market equilibrium price.

Supply
Price
P min
Price Floor (Guaranteed)
Pe
Demand
Q1
Q2
Quantity
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Price support in a buffer stock

• If the government is to maintain the guaranteed
  price at P min, then it must buy up the excess
  supply (Q2-Q1) and put these purchases into
  intervention storage.

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

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Rising supply more intervention
How much would the market buy?
Supply
S2
Price
P min
Price Floor (Guaranteed)
Pe
How much would Govt buy?
P2
Demand
Q1
Q3
Q2
Q4
Quantity
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Does it really work?
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Consider this diagram
Max
Min
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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?

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Consider this diagram
Max
Min
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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 Q1-Q2 on to the market thus preventing the
  price rising to P4.

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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?
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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.

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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

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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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Exam skills

• Using at least one demand and supply diagram and
  the information in Extract B, explain how ????
  might try to stabilise the world price of ???
  between 55 and 65?

Any exam Q on price stability requires Buffer
stock diagrams!