buffer stocks and government price support schemes
The prices of agricultural products tend to fluctuate more violently
than the price of manufactured products and services. This is largely due
to the volatility in the supply of agricultural products coupled with the
fact that demand and supply are price inelastic. One way to smooth out the
fluctuations in prices is to create a buffer stock scheme.
Buffer stock schemes seek to stabilise the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low. Examples of buffer stock schemes include the International Tin Council support scheme, which collapsed in 1985. The diagram below can be used to illustrate the operation of a buffer stock scheme:
The supply curves S1 and S2 represent the supply of wheat at the end of two different seasons. Supply is perfectly inelastic since farmers cannot change the quantity supplied onto the market post harvest. The organisation wishes to keep price fluctuations within a certain band: it will not allow the price of the product to rise above P max or to fall below P min.
that in one particular year there is a bumper harvest so that S1
is supplied onto the market. In absence of any intervention the market price
would drop below P min,
so the organisation buys up AB
of the product to increase the market price up to P min. In the next year
bad weather may result in a poor harvest so that only S2 is supplied. The market price would rise above the maximum permitted
by the organisation, so the organisation sells CD of its stocks onto the market to reduce the price to P
theory buffer stock schemes should be profit making, since they buy up stocks
of the product when the price is low and sell them onto the market when the
price is high. However, they do not often work well in practice. Clearly,
perishable items cannot be stored for long periods of time and can therefore
be immediately ruled out of buffer stock schemes. Setting up a buffer stock
scheme also requires a significant amount of start up capital, since money
is needed to buy up the product when prices are low. There a re also high
administrative and storage costs to be considered.
The success of a buffer stock scheme however ultimately depends on its ability to correctly estimate the average price of the product over a period of time. This estimate is the schemes target price and obviously determines the maximum and minimum price boundaries. But if the target price is significantly above the correct average price then the organisation will find itself buying more produce than it is selling and it will eventually run out of money. The price of the product will then crash as the excess stocks built up by the organisation are dumped onto the market. Conversely if the target price is too low then the organisation will often find the price rising above the boundary, it will end up selling more than it is buying and will eventually run out of stocks.
revision notes kindly provided by Ian Black from St Albans School
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