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
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
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
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
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
Price Discovery Mechanisms
Individual Agreements – peer to peer, private
Group Actions – public arena – groups of agents
Government Influences - interventions
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
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)
Source: MacDonald, J.M. and Penni Korb. Agricultural Contracting Update: Contracts in 2008. ERS-USDA, Bulletin Number 72, February 2011
Source: MacDonald, J.M. and Penni Korb. Agricultural Contracting Update: Contracts in 2008. ERS-USDA, Bulletin Number 72, February 2011
Source: MacDonald, J.M. and Penni Korb. Agricultural Contracting Update: Contracts in 2008. ERS-USDA, Bulletin Number 72, February 2011
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
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
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
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
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
Price discovery – many alternative institutions
Choice – Benefits/Costs (Transactions costs)
Dynamic
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