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Price Determination and Discovery

Price Determination and Discovery. Price Determination is the broad forces of supply and demand establishing a market clearing price for a commodity. Price Discovery

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Price Determination and Discovery

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  1. 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 lotof produce at a given locationfor a specifictimeperiod.

  2. 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.

  3. Price Determination and Price Discovery S P Pe D Q Qe

  4. 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

  5. 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

  6. Decentralized Pricing • One-to-one negotiations • Reduced transportation cost • Reduced transaction cost • Depends on skills and information • Higher search cost

  7. 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

  8. 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 ??????

  9. Important market functions • Assembly function • Feeder cattle • Cull cows • Sorting function

  10. 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

  11. Hybrid markets • Electronic markets • Centralized pricing • Decentralized product movement • Examples • Satellite auctions • Electronic auctions • Tel-o-auction • E-commerce

  12. 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?

  13. Feeder Pig Trade • Formula pricing • Based on observable price • Spot market • Hog futures maybe corn & SBM • Spot market price • Often through a broker • USDA report Formula ex: 53% of 5 month out futures

  14. Performance issues • “Least cost” method of price discovery • Effect of the mechanism on price behavior • Marketing v. pricing efficiency

  15. 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

  16. 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

  17. Derived Demand Vertical distance is the difference is price at 3 levels There is cost associated with moving from one level to the next S Px Pretail Pwholesale Pfarm Dretail Cuts of meat Carcasses Animals Dwholesale Dfarm Q Qx

  18. 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

  19. 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

  20. 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.

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