Chapter 5. PRICE DISCOVERY By : Nur Baladina, SP. MP.

INTRODUCTION PRICE DETERMINATION: the process by which the broad forces of supply and demand establish a general, market-clearing, equilibrium price for a commodity. PRICE DISCOVERY: the process by which buyers and sellers arrive at specific price for a given lot of produce in a given location. The equilibrium price target must be “discovered” and applied to each transaction in the marketplaces.

FIVE SYSTEMS OF PRICE DISCOVERY Five systems of price discovery for farm products have been identified: 1. Individual, decentralized negotiation 2. Organized, central market trading 3. Formula Pricing 4. Bargained Prices 5. Administered Prices

INDIVIDUAL, DECENTRALIZED NEGOTIATIONS Each farmer bargains separately with buyers of farm products until a price is established. Private treaty negotiations are quite common in agriculture. The resulting fairness of prices depends on the information, trading skills, and relative bargaining power of buyers and sellers.

Consequently, price discovered in this way tend to vary widely for different transactions. The time and energy costs of this form of price discovery are rather high compared with the alternatives.

ORGANIZED, CENTRAL MARKETS The central markets shift the locus of price discovery from the farm gate to a central marketplace. All buyers and sellers and their supplies and demand are represented in the central market. These markets generate considerably more information than private treaty markets and probably also reduce some costs of price discovery. Examples: Terminal markets, auctions markets

FORMULA PRICING SYSTEMS Formula pricing system evolved in attemps to secure the benefits of central market price discovery without physically routing all produce through central markets. Egg producers for example, frequently are paid a formula price by the government. These prices are adjusted, again by formula, for transport costs and quality differences.

Formula pricing can reduce transaction and bargaining costs. However, formulas can become obsolete, moreover, they require at least one “correct” price on which to base other prices.

BARGAINED PRICES Bargaining implies collective pricing on the part of farmers. The collective bargaining process used in labor is frequently cited as the model for farmers to follow in order to discover farm prices. There are differences in labor and farm products.

ADMINISTERED PRICING SYSTEMS The government becomes a third party in the price discovery process. Price supports, price ceilings, and supply control programs are the techniques of administered pricing that have been used for a number of agricultural products.

Bargained price discovery probably works best when there are relatively few producers in a concntrated geographic area selling a product that can be stored or withheld from the market. Bargained prices are common for fruits, vegetables, nuts, and milk.