Chap 8 - Price Discovery Meaning of Price Discovery Classifying Price Discovery Mechanisms Different...
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Transcript of Chap 8 - Price Discovery Meaning of Price Discovery Classifying Price Discovery Mechanisms Different...
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Chap 8 - Price Discovery
Meaning of Price Discovery
Classifying Price Discovery Mechanisms
Different Price Discovery Mechanisms
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RIP - MF Global Holdings (Oct 31, 2011)Sales $2.3 Billion Assets $50 Billion
Liabilities $44.5 Billion Liabilities-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
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Price Discovery Process -Mechanism - Institution
arrange acceptable terms of trade for transfers of ownershiptrue willingness to pay/accept payment
Diversity - systems used
across commodities: house, food, powerAcross locationsOver time
Costs & Benefits
Every transfer involves costs – cost of price discovery
Different mechanisms => different investments of time & resources
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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) marketsAlternative mechanisms
Agricultural industrializationmore contractingcontinuing ownership of products through successive stages of marketing
More marketing services => + changes in ownership
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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, andcoalitions of buyers and sellers
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Price Discovery Mechanisms
Individual Agreements – peer to peer, private
Group Actions – public arena – groups of agents
Government Influences - interventions
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Individual AgreementsDistinguishing 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 sellerassurance 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
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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
C4 hog slaughter - increased 20% over 10 years, to 64% in 2004
C4 cattle slaughter - 70% (2004)
Marketing Contracts:1993 87% of hogs sold on spot market
200670% of hogs sold using contracts20% owned and slaughtered by the packer10% sold via “negotiated purchase” (spot market)
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Source: MacDonald, J.M. and Penni Korb. Agricultural Contracting Update: Contracts in 2008. ERS-USDA, Bulletin Number 72, February 2011
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Source: MacDonald, J.M. and Penni Korb. Agricultural Contracting Update: Contracts in 2008. ERS-USDA, Bulletin Number 72, February 2011
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Source: MacDonald, J.M. and Penni Korb. Agricultural Contracting Update: Contracts in 2008. ERS-USDA, Bulletin Number 72, February 2011
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Contract Broiler ProductionHigh level of vertical co-ordination – “integrator” & farmers
Integrator:
Breeding flocks, hatcheries, feed mills, processing plantsProvides chicks, feed, medications, technical advise, managerial oversightResponsible for processing & marketing
Farmer: housing (25,000 sqft per house; 50,000 birds), litter, labour
Increased efficiency, uniform birdsReduced land & capital requirement vs full integration
Reduced capital & expertise requiredReduced marketing riskLow return to labour in early years
Price – “negotiated” – with premium + discountsFew integrators
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Individual AgreementsDistinguishing 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 skillsvalue of the sale is relatively largeability to price discriminateBenefit > transaction cost
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Individual AgreementsDistinguishing 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 ContractPremiums/discounts - quality variations
Price determined outside public markets – information loss
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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) DutchFirst price Second price (Vickrey)Double auctions (CBOT)
WTP ≥ English = Second price > First > Dutch
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Group Bargaining
Multiple agents cooperate
countervailing power (marketing boards/co-ops)willingness to finance costsrequires group solidarity – no “free riding”
CWB – “public goods”
Government Intervention Enabling legislationPhysical facilities Information (USDA/Agr-Can)
Direct Interventionminimum or maximum pricesregulated industry groups
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Price discovery – many alternative institutions
Choice – Benefits/Costs (Transactions costs)
Dynamic