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Chapter 5. Agricultural Prices. Purpose of the Chapter. To extend our supply and demand model to incorporate specific features of agriculture to better understand agriculture prices. Covers four determinants of agricultural price changes
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Chapter 5 Agricultural Prices
Purpose of the Chapter • To extend our supply and demand model to incorporate specific features of agriculture to better understand agriculture prices. • Covers four determinants of agricultural price changes • Shows how to construct time-series diagrams in the presence of seasonality, market shocks, and production lags • Reviews the causes and nature of price cycles
Understanding Agricultural Prices • Changes in Agricultural prices are caused by: • Changes in long-run supply and demand • Seasonality • Supply and demand (or market) shocks • Market adjustments
Changes in Long-Run Supply and Demand • Successful agribusinesses develop their strategies with a long-run view. • When long-run supply increases, the long-run supply curve shifts downward and the price begins a decline. Figure 5.1. Over Many Years, Agricultural Prices are Determined by the Intersection of Long-Run Supply and Demand
Example: Corn Market Over the Last Century Figure 5.2. Corn Through the Years
Example: Fed-Cattle Market Over the Last Century Figure 5.3. Fed-Cattle Market Through the Years
Seasonality • The impact of seasonality is most obviously seen in crop production. • Like in Chapter 1, price should continually rise in the months between harvest to provide incentives for people to store the grain. • Think back to the Indifference Principle. • The price rise each month between harvests to compensate those who incur storage costs. • Convenience Yield: It is more convenient to secure one’s crop supplies early than have to scramble around in search of more of the crop should supplies run low.
Example of Seasonality Prices rise in the months after harvest up until the next harvest to compensate for storing the grain for consumer use. Figure 5.5. The Price of a Crop Should Continually Rise Between Harvests
Corn Prices do not behave like the predictor slide previous states. Prices rise until May, to compensate for storage, then steadily decline until the next harvest because grain can be bought cheaper in August and not have to pay storage costs. Source: LMICb. Notes: Prices reported for each month are the average monthly price between 1990 and 2005. Figure 5.6. U.S. Corn Prices Between Harvests (corn is harvested around November)
Figure 5.7. Nebraska Wheat Prices Between Harvests (wheat is harvested around July) Source: NASS. Notes: Prices reported for each month are the average monthly price between 1990 and 2005.
Figure 5.8. Time-Series Diagram of Crop Prices With Long-Run Equilibrium and Seasonal Variation
Most Stocker-Calves are born from end-January to beginning-March. This is because of the nutritional needs of cow and calf. These calves would be ready to sell in September/October. In these months the price for calves is lower. To make the Indifference Principle hold true, prices should be indifferent to sellers, making the prices in the early months of the year greater. Figure 5.9. Stocker-Calf Prices By Month Source: LMIC Notes: Prices are the average Oklahoma feeder cattle prices 400-500 lbs, 1992-2001.
Market (Supply and Demand) Shocks • Some aspects of agricultural prices are unpredictable and appear somewhat random. • Market Shocks: • Positive Demand Shock: unexpected, temporary increase in demand (i.e. USSR buying US grain) • Negative Demand Shock: unexpected, temporary decrease in demand (i.e. Hurricane Katrina affected grain ports) • Positive Supply Shock: unexpected, temporary increase in supply (i.e. Good weather increasing supply) • Negative Supply Shock: unexpected, temporary decrease in supply (i.e. events that temporarily decrease supply)
Market Adjustments • When temporary price changes occur, markets have to rediscover their long-run equilibrium, which can take time. • Markets must adjust to shocks because of agricultural production experiences production lags: time lags between the time production decisions are made and the output is produced. • Cows: 2 years from when the cow is bred to the time her calf is ready for slaughter. • Chickens: little more than a month
Cobweb Model • Assumptions of Cobweb Model • Production lag • Producers make production decisions for the future based on current prices
Figure 5.15. Time-Series Diagram with Market Shock and Market Adjustments
Figure 5.16. Time-Series Diagram with Market Shock, Seasonality, Market Adjustments, and a Declining Long-Run Equilibrium Price
Price Cycles • Prices go up, then prices go down. • Expansion Phase: producers are building up their breeding stock to produce more stock in the future. • Liquidation or Contraction Stage: planning to produce fewer stock in the future Figure 5.17. Illustration of Livestock Price Cycles
How Livestock Cycles Affect Profits Figure 5.18. Profits from Cow-Calf Production Source: Feedstuffs 2005.
