Spatial Price Analysis –Physical Balance Equilibrium

1. Spatial Price Analysis –Physical Balance Equilibrium Markets and Prices in Agribusiness AG BM 420

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 ) 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) Pk = P1 + AC(Y1k ) Trade past the green frontier is not profitable! Pj = P1 + AC(Y1j ) Markets and Prices in Agribusiness

4. Spatial arbitrage – suppose there is a barrier to any trade Source Region Pj=AC(Yj) Destination Region Pi =AC(Yi) 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 Markets and Prices in Agribusiness

5. Arbitrage forces physical balance Physical balance is the rule that within a trading area • Excess demand = excess demand • Total demand = total supply • Prices adjust to make this happen 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 - Ydti = Yxti exports Suppose region j has excess demand @ trade price Excess demand = Yd ti - Ysti = Ymti imports Markets and Prices in Agribusiness

7. Physical balance equilibrium Excess supply = Ysti - Ydti = Yxti Excess demand = Ydtj - Ystj = Ymtji So since Exports = Imports Yxti = Ymtji Excess supply = Ysti - Ydti = Excess demand = Ydtj - Ystj Markets and Prices in Agribusiness

8. Physical balance equilibrium Exports = Imports Yxti = Ymtji Ysti - Ydti = Ydtj - Ystj We can re-arrange collecting supply on one side…. Ysti + Ystj= Ydtj + Ydti  Total supply = Total Demand Markets and Prices in Agribusiness

9. Physical balance implications for prices Let’s add prices, remember Pi and Pj ….affect decisions……and lets ignore other drivers so Ydti (Pit ) – Ysti (Pit ) = Ystj (Pjt ) - Ydtj (Pjt ) Interpretation? Simple…. The prices in the two regions Pit and Pjt are jointly determined Markets and Prices in Agribusiness

10. Physical balance implications for prices Let’s add other drivers so Ydti (Pit ,Ijt ,Djt ) – Ysti (Pit ,Rjt ,Kjt) = Ystj (Pjt ,Rjt ,Kjt) - Ydtj (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! Markets and Prices in Agribusiness

11. Spatial arbitrage – suppose Excess Supply Region Excess Demand 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 ) Together, 1) & 2)  Pi Pj Yij 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 ) – Ysti (Pit ,Rjt ,Kjt) = Ystj (Pjt ,Rjt ,Kjt) - Ydtj (Pjt ,Ijt , Djt ) Arbitrage equilibrium in price is established Pit = Pjt + ACijt 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 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? 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 established Excess demand = Excess supply 1) Ydti (Pit ,Ijt ,Djt ) – Ysti (Pit ,Rjt ,Kjt) = Ystj (Pjt ,Rjt ,Kjt) - Ydtj (Pjt ,Ijt , Djt ) Arbitrage equilibrium in price is established 2) Pi = Pj + ACij Markets and Prices in Agribusiness

16. In reality, spatial arbitrage involves multiple markets Markets and Prices in Agribusiness

17. Practical implications Income increases in China  excess demand for Cement Plywood Flat screen tvs Motor scooters Automobiles Wheat Sugar • China’s import demand increases • increase exports from US • Increased prices in the US 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?? Markets and Prices in Agribusiness