Price Determination and Discovery

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Price Determination and Discovery

• Price Determination
• is the broad forces of supply and demand
  establishing a market clearing price for a
  commodity.
• Price Discovery
• is the process by which buyers and sellers arrive
  a a specific price for a given lot of produce at
  a given location for a specific time period.

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Price Discovery

• A human process, subject to relative bargaining
  power of the buyer and seller.
• Two stage process
• Evaluate SD and Pe
• Estimate the price for the specific trade.

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Price Determination and Price Discovery

S
P

Pe
D
Q
Qe
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Futures Markets in Price Discovery

• Centralized pricing
• Global forces in one location
• Predominate price discovery for grains
• Still have local price discovery for basis
• Livestock price discovery more complicated
• Variability basis a bigger issue
• Growing inventory problem

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Centralized pricing

• All buyers and sellers in one place at one time,
  i.e., auction market
• Full and immediate information
• Competitive bidding
• Equalizes market power
• Transaction cost
• Physical movement of product

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Decentralized Pricing

• One-to-one negotiations
• Reduced transportation cost
• Reduced transaction cost
• Depends on skills and information
• Higher search cost

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Where to sell

• Terminal markets have declined
• Auction markets important when assembly is needed
• Feeder cattle and cull cows
• Growing interest in fed cattle in fringe areas
• Direct sales
• Slaughter cattle and hogs
• Feeder pigs
• Growing in feeder cattle where source
  verification is important

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Feeder cattle sales

• Live weight sales
• Various weight classes
• In general, lower / and heavier weights
• Auction is major market
• Assembly function important
• Video auctions
• Direct trade
• Premium paid for
• Large uniform lots
• Certification/verification ??????

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Important market functions

• Assembly function
• Feeder cattle
• Cull cows
• Sorting function

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Slaughter Cattle and Hogs

• Direct sales most common
• Animals are delivered directly to the packing
  plant
• Spot or cash market
• Seller contacts buyer when ready to sell
• Negotiate price and terms on each group
• Contract market
• May be for one group or an ongoing agreement
  between buyer and seller
• Terms and pricing method determined ahead of
  marketing date

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Hybrid markets

• Electronic markets
• Centralized pricing
• Decentralized product movement
• Examples
• Satellite auctions
• Electronic auctions
• Tel-o-auction
• E-commerce

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Formula pricing

• Price discovery from elsewhere
• Formula contracts
• Spot market
• Cutout price
• Futures
• Cost of production
• Do you trust the underlying market for price
  discovery?

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Feeder Pig Trade
Formula pricing Based on observable price Spot
market Hog futures maybe corn SBM
Spot market price Often through a broker USDA
report
Formula ex 53 of 5 month out futures
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Performance issues

• Least cost method of price discovery
• Effect of the mechanism on price behavior
• Marketing v. pricing efficiency

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Information and markets

• Price reporting
• Role of the government
• Collection and dissemination and timely reporting
  of prices that were discovered.
• Other private treaty buyers and sellers
  incorporate new information into their
  negotiation.
• Facilitates formula pricing

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Packer Offering Price

• Starts with derived demand from wholesale and
  retail markets
• Time lag between sales of product and purchase of
  animals.
• Orders typically booked 3 weeks in advance.
• Special features, holidays etc may be longer.
• Clean up orders may be few days
• Packer is anticipating prices and stands risk

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Derived Demand
Vertical distance is the difference is price at 3
levels There is cost associated with moving from
one level to the next
S
Px
Pretail
Pwholesale
Pfarm
Dretail
Cuts of meat Carcasses Animals
Dwholesale
Dfarm
Q
Qx
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Derived Demand for Pork

• Average retail price /lb 2.50
• Value of trim and scrap /lb 0.10
• Costs from whlse -retail /lb -1.00
• The most retail will pay /lb 1.60
• Retail pounds per carcass 100
• The most retail will pay /head 160

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Derived Demand for Hogs

• Wholesale carcass value /hd 160
• Value hide and offal /hd 25
• Costs to slaughter and fab /hd -20
• The most packer will pay /hd 165
• Wholesale pounds per carcass 200
• The most packer will pay /lb 82.50

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Producer Asking Price

• Starts with cost of production
• Reflects current market conditions
• Time is a huge factor for livestock
• Marginal revenue may decrease
• Marginal cost increases at increasing rate
• Farmer has longer time period than packer from
  start of process to end.