price determination and discovery uprice determination is the broad forces of supply and demand...
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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.
Price Discovery
A human process, subject to relative bargaining power of the buyer and seller.
Two stage process• Evaluate S&D and Pe• Estimate the price for the specific trade.
Price Determination and Price Discovery
S
D
P
Q
Pe
Qe
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
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
Decentralized Pricing
One-to-one negotiations+ Reduced transportation cost+ Reduced transaction cost- Depends on skills and information- Higher search cost
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
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 ??????
Important market functions
Assembly function• Feeder cattle • Cull cows
Sorting function
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
Hybrid markets
Electronic markets• Centralized pricing• Decentralized product movement
Examples• Satellite auctions• Electronic auctions• Tel-o-auction• E-commerce
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?
Spot market priceOften through a broker
USDA report
Feeder Pig TradeFormula pricing
Based on observable priceSpot marketHog futures maybe corn & SBM
Formula ex: 53% of 5 month out futures
Performance issues
“Least cost” method of price discovery
Effect of the mechanism on price behavior
Marketing v. pricing efficiency
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
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
Derived Demand
Px
Qx
Dfarm
Dretail
S
Pretail
Pfarm
Q
Dwholesale
Pwholesale
Cuts of meat
Carcasses
Animals
Vertical distance is the difference is price at 3 levels
There is cost associated with moving from one level to the next
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
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
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.