The Law of One Price and Agricultural Markets AG BM 102

Introduction Markets seem confusing at first Lots of products, lots of prices Time, place, & product form They are much more orderly than meets the eye Reason – law of one price

Law of One Price - The economic principle that the same item or closely equivalent items must sell for the same price or related prices in the marketplace

What this means One big corn market Price now and price later linked by storage cost Price in Pennsylvania and Chicago linked by transport costs Price of corn and price of corn oil linked by processing costs

In practice Prices move together Market forces affect whole market Arbitrage keeps things orderly – Jesse Livermore May not exactly match but pretty close

Arbitrage -Attempting to profit by exploiting price differences of identical or similar products, on different markets or in different forms. The ideal version is risk- less arbitrage.

Transportation One important linkage Key provider of utility Creates spatial markets

Some vocabulary terminal costs - costs of loading, unloading, scheduling, etc. that are part of the cost of moving a product from one place to another but do not vary with distance. Inter-modal transportation - shipment of a product using more that one medium of transportation, such as truck and rail. backhaul - the return loading after hauling a cargo from A to B, i.e. a load that moves from B to A.

Shipment Size Larger shipments are cheaper per unit to send One box A few boxes A truckload A train car load A unit train

Zonal Rates Step wise rates Box to PA – rate 1 Box to neighboring states – rate 2 Box to states beyond Mississippi River – rate 3 Box to Alaska or Hawaii – rate 4

Costs and Product Characteristics Some examples? Liquid Bulk Palletized Hazardous Special handling Cars

Price mountains Prices higher close to market

Price mountain Important for things you sell Farm-gate price is market price less freight costs The farther you are from market the higher the freight costs and the lower the net price

Price valleys Prices lower close to market

Price Valleys Apply to things you buy Farm-gate price is market price plus freight The farther you are from market the more the freight and the higher your net price

Concluding Comments Law of One Price applies to most ag. Commodities Transportation costs one linkage between markets Need to understand transport costs to understand economics of rural areas