1. Spatially Separated Markets AG BM 102

2. Introduction Interregional competition is an important part of agriculture How can they afford to ship those potatoes all the way from Idaho? Can’t we compete with our potatoes? If energy prices rise, will our peach industry be more competitive? Why isn’t Pennsylvania more self-sufficient in food production?

3. Basic situation Two regions – west & east Each has a supply, each has a demand With no trade, each would be self- sufficient in this crop – potatoes With trade, part of the eastern market is served by western potatoes.

4. Some Intuition Potato price in west without trade is $5/cwt. Potato price in east without trade is $11/cwt. Costs $1 per cwt to ship potatoes across country – either way. Could you buy potatoes in east and sell them in west?

5. Intuition (cont.) How much would you make? Could you buy potatoes in west and sell them in the east? How much would you make? If you did, what would happen to the price in the east? What would happen to the price in the west?

6. Intuition (cont.) At what point would you quit shipping potatoes? Why? America now has one big potato market P east = P west + freight Total Quantity Demanded = Total Quantity Supplied

7. Some Math No Trade

8. An Example Market 1 No Trade

9. Market 2 No Trade

10. Things to Notice Market 1 has a higher price than market 2 The price difference is greater than the transport price, which is $2 So, someone could buy in market 2 at $5, ship to market 1 at a cost of $2, and sell it for $12 and make money

11. Math With Trade, if P 1 <P 2 If P 1 >P 2 then

12. Math with trade

13. With Trade (cont.)

16. Excess Function Market 1

17. Excess Function – Market 2

21. Steps for solving Solve without trade Find high-priced market (h) and low priced market (l) P h = P l + P t S h + S l = D h + D l Substitute in values and solve for Prices and quantities

22. How to do graphs You need three graphs: market 1, market 2, and trade Put the supply and demand curves on market 1 & 2 graphs Put excess demand on the graph for the high priced market Put excess supply on the graph for the low priced market

23. Put excess demand and excess supply on the trade graph Add the transportation cost to the excess supply curve Where this line crossed excess demand determines the price in the high priced market with trade and the quantity traded At that quantity, the price in the low priced market is where it crosses excess supply

24. Plot the with trade prices on each market’s graph and identify quantity supplied, quantity demanded and quantity traded

25. Remember the excess demand is always the high priced market and excess supply the low prices market

26. Concluding Comments Concept is easy – Price differences encourage trade Trade pushes prices closer together- until price difference equals transport costs Math and graphs are more complicated Our whole economy depends on this Every meal we eat reflects it