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Chap 8 - Price Discovery Meaning of Price Discovery Classifying Price Discovery Mechanisms Different Price Discovery Mechanisms.

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Presentation on theme: "Chap 8 - Price Discovery Meaning of Price Discovery Classifying Price Discovery Mechanisms Different Price Discovery Mechanisms."— Presentation transcript:

1 Chap 8 - Price Discovery Meaning of Price Discovery Classifying Price Discovery Mechanisms Different Price Discovery Mechanisms

2 RIP - MF Global Holdings (Oct 31, 2011) Sales $2.3 BillionAssets $50 Billion Liabilities $44.5 BillionLiabilities-to-Equity Ratio 32:1 Earnings - $76.7 Million Filed for Chapter 11 bankruptcy - bad bets on European debt “Extensive Riskitis” - could not be saved

3 Price Discovery Process -Mechanism - Institution arrange acceptable terms of trade for transfers of ownership true willingness to pay/accept payment Diversity - systems used across commodities: house, food, power Across locations Over time Costs & Benefits Every transfer involves costs – cost of price discovery Different mechanisms => different investments of time & resources

4 Factors Affecting Number of Changes in Ownership Economies of scale Greater control – quality, quantity & timeliness Cost of arranging transfers of ownership (TC’s) Consequence: Less trade through spot (terminal) markets Alternative mechanisms Agricultural industrialization more contracting continuing ownership of products through successive stages of marketing More marketing services => + changes in ownership

5 March 12, 2001 – Headline - Feedstuffs due to declining volumes,the cash (spot) market for hogs in the US will be non-existent within 5 years what mechanisms will be used to establish (discover) the price of hogs? prices in cash market are signals to market participants efficiency = f(extent to which prices give correct signals) System of price discovery must be robust to: mis-representation of preferences, small or unequal numbers of buyers and sellers, and coalitions of buyers and sellers

6 Price Discovery Mechanisms Individual Agreements – peer to peer, private Group Actions – public arena – groups of agents Government Influences - interventions

7 Individual Agreements Distinguishing Different Types of Transactions 1 - When does exchange of ownership occur? Immediate or in the future? Forward contracts (marketing/production contracts) vertical co-ordination reduce price risk faced by buyer and seller assurance of quality characteristics for buyer (quality risk) Alternative to contracting - vertical integration replaces transfers with an alternative set of contracts within the firm Common in chicken, eggs, turkey

8 US Hog Production and Slaughter Hogs on farms with more than 2,000 head 38 % in 1994 79 % in 2004 Source: Martinez, Steve. The U.S. Food Marketing System: Recent Developments, 1997-2006. ERS, Economic Research Report, Number 42: Washington, May 2007 C 4 hog slaughter - increased 20% over 10 years, to 64% in 2004 C 4 cattle slaughter - 70% (2004) Marketing Contracts: 199387% of hogs sold on spot market 2006 70% of hogs sold using contracts 20% owned and slaughtered by the packer 10% sold via “negotiated purchase” (spot market)

9 Source: MacDonald, J.M. and Penni Korb. Agricultural Contracting Update: Contracts in 2008. ERS-USDA, Bulletin Number 72, February 2011



12 Contract Broiler Production High level of vertical co-ordination – “integrator” & farmers Integrator: Breeding flocks, hatcheries, feed mills, processing plants Provides chicks, feed, medications, technical advise, managerial oversight Responsible for processing & marketing Farmer: housing (25,000 sqft per house; 50,000 birds), litter, labour Increased efficiency, uniform birds Reduced land & capital requirement vs full integration Reduced capital & expertise required Reduced marketing risk Low return to labour in early years Price – “negotiated” – with premium + discounts Few integrators

13 Individual Agreements Distinguishing Different Types of Transactions 2 - How is price negotiated ? Pricing Arrangements Explicit (Posted) Price OR Negotiated Price? When it is worthwhile for agents to bargain/negotiate ? potential gain through good negotiating skills value of the sale is relatively large ability to price discriminate Benefit > transaction cost

14 Individual Agreements Distinguishing Different Types of Transactions Price for future delivery: Deferred pricing according to a formula? Predetermined price - Price & quality risk -feel cheated - - potential for default – transaction cost Alternative – Predetermined mechanism for price Link price to some “anchor price” – e.g. Basis Contract Premiums/discounts - quality variations Price determined outside public markets – information loss

15 Group Actions Auctions competitive - revelation of valuation (livestock, EBay) more or less public location - electronic auctions and efficiency single or multiple items simultaneously Vernon Smith (2002) auctions and economic experiments Auction structures – strategies + price (valuation WTP) English (open outcry)Dutch First priceSecond price (Vickrey) Double auctions (CBOT) WTP ≥ English = Second price > First > Dutch


17 Group Bargaining Multiple agents cooperate countervailing power (marketing boards/co-ops) willingness to finance costs requires group solidarity – no “free riding” CWB – “public goods” Government Intervention Enabling legislation Physical facilities Information (USDA/Agr-Can) Direct Intervention minimum or maximum prices regulated industry groups

18 Price discovery – many alternative institutions Choice – Benefits/Costs (Transactions costs) Dynamic

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