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 lot of produce at a given location for a specific time period.

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.

Price Determination and Price Discovery

S

D

P

Q

Pe

Qe

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

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

Decentralized Pricing

One-to-one negotiations+ Reduced transportation cost+ Reduced transaction cost- Depends on skills and information- Higher search cost

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

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 ??????

Important market functions

Assembly function• Feeder cattle • Cull cows

Sorting function

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

Hybrid markets

Electronic markets• Centralized pricing• Decentralized product movement

Examples• Satellite auctions• Electronic auctions• Tel-o-auction• E-commerce

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?

Spot market priceOften through a broker

USDA report

Feeder Pig TradeFormula pricing

Based on observable priceSpot marketHog futures maybe corn & SBM

Formula ex: 53% of 5 month out futures

Performance issues

“Least cost” method of price discovery

Effect of the mechanism on price behavior

Marketing v. pricing efficiency

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

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

Derived Demand

Px

Qx

Dfarm

Dretail

S

Pretail

Pfarm

Q

Dwholesale

Pwholesale

Cuts of meat

Carcasses

Animals

Vertical distance is the difference is price at 3 levels

There is cost associated with moving from one level to the next

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

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

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.