Spatial Price Analysis –Physical Balance Equilibrium

Spatial Price Analysis –Physical Balance Equilibrium

Markets and Prices in Agribusiness

AG BM 420

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

2

Arbitrage effects

Prices adjust across regions Product is moved……

We saw arbitrage results in an equilibrium condition a rule that always applies in competitive markets….that relate prices across prices.

Arbitrage forces structure on prices!

Pj = P1 + AC(Y1j )

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

3

Thinking in terms of economic geographyEconomics tells us how to find the boundaries of an economic region!

Supply Region

P1 =AC(Y1)

Pj = P1 + AC(Y1j )

Pk = P1 + AC(Y1k )

Trade past the green frontier is not profitable!

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

4

Spatial arbitrage – suppose there is a barrier to any trade

Source Region

Pj=AC(Yj)

Spatial arbitrage is not in equilibrium

Pi > Pj + AC(Yij )

Why is this a problem?

Region i would be paying more for the good then they need to if arbitrage were allowed…….Region i welfare would be reduced.

Region j could supply region i but can’t so region j has reduced welfare

Destination Region

Pi =AC(Yi)

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

5

Arbitrage forces physical balancePhysical balance is the rule that within a trading area

Excess demand = excess demand

Total demand = total supply

Prices adjust to make this happen

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

6

Physical balance equilibrium

Recall, for a single market, we said quantities must balance across supply sources and types of utilization

Suppose region i has excess supply @ trade price

Excess supply = Ysti - Yd

ti = Yxti exports

Suppose region j has excess demand @ trade price

Excess demand = Yd ti - Ys

ti = Ymti imports

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

7

Physical balance equilibrium

Excess supply = Ysti - Yd

ti = Yxti

Excess demand = Ydtj - Ys

tj = Ymtji

So since Exports = Imports

Yxti = Ym

tji

Excess supply = Ysti - Yd

ti

= Excess demand = Ydtj - Ys

tj

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

8

Physical balance equilibrium

Exports = Imports

Yxti = Ym

tji

Ysti - Yd

ti = Ydtj - Ys

tj

We can re-arrange collecting supply on one side….

Ysti + Ys

tj = Ydtj + Yd

ti

Total supply = Total Demand

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

9

Physical balance implications for pricesLet’s add prices, remember Pi and Pj ….affect

decisions……and lets ignore other drivers so

Ydti (Pit ) – Ys

ti (Pit )

= Ystj (Pjt ) - Yd

tj (Pjt )

Interpretation? Simple…. The prices in the two regions Pit and Pjt are jointly determined

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

10

Physical balance implications for pricesLet’s add other drivers so

Ydti (Pit ,Ijt ,Djt ) – Ys

ti (Pit ,Rjt ,Kjt)

= Ystj (Pjt ,Rjt ,Kjt) - Yd

tj (Pjt ,Ijt , Djt )

Interpretation? Simple…. The prices in the two regions Pit and Pjt are jointly determined by all the drivers affecting demand and supply in each region!

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

11

Spatial arbitrage – suppose

Excess Supply Region

Spatial arbitrage equilibrium condition

1) Pi = Pj + AC(Yij ) then product would be arbitraged from j to i

Physical balance condition across trading regions

2) Excess demandi (Pi )= excess supplyj ( Pj )

Excess Demand Region

Together, 1) & 2) Pi Pj Yij

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

12

Bottom-line

Arbitrage knits regions together binding the markets together such that

Physical balance is established

Ydti (Pit ,Ijt ,Djt ) – Ys

ti (Pit ,Rjt ,Kjt)

= Ystj (Pjt ,Rjt ,Kjt) - Yd

tj (Pjt ,Ijt , Djt )

Arbitrage equilibrium in price is established Pit = Pjt + ACijt

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

13

Important result

Stuff (drivers) in export region affects prices in import region, and vice versa!

Bad weather in Montana affects Montana hay price,…….but also the price of hay in PA!

Hurricane in Nawlins affect plywood prices there and also those in PA!

Unemployment in China affects hockey puck prices in the US

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

14

Practical implications

Suppose you run a dry cleaning business in Williamsport, PA 30 minutes from State College

Price for a shirt is low in Williamsport, and your plant has excess capacity

Price of a shirt is 26% higher in State College.Should you open a home pick/delivery route in State College?

At current prices? But what will happen to those prices as you shift service capacity to State College? What will happen to your Williamsport price if unemployment increases in State College?

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

15

Price determination

We need to determine two prices, so we need two equations and we have ‘em!

Physical balance is establishedExcess demand = Excess supply

1) Ydti (Pit ,Ijt ,Djt ) – Ys

ti (Pit ,Rjt ,Kjt)

= Ystj (Pjt ,Rjt ,Kjt) - Yd

tj (Pjt ,Ijt , Djt )

Arbitrage equilibrium in price is established2) Pi = Pj + ACij

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

16

In reality, spatial arbitrage involves multiple markets

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

17

Practical implicationsIncome increases in China excess demand for

CementPlywoodFlat screen tvsMotor scootersAutomobilesWheatSugar

China’s import demand increases increase exports from US Increased prices in the US

(c) R.D. Weaver AGBM 420

Markets and Prices in Agribusiness

18

Implications for your product market Identify the most important regional markets linked by

spatial arbitrage to your product’s market Set up a spreadsheet and collect & track

Supply & utilization quantity data for your market and each important spatially linked market

Prices for your product in your market & spatially linked markets Drivers of demand and supply in your market & spatially linked

markets

Why does Walmart have cashiers ask you for your zip code when you check out??