1. Econ 337, Spring 2014 ECON 337: Agricultural Marketing Chad Hart Associate Professor chart@iastate.edu 515-294-9911 Lee Schulz Assistant Professor lschulz@iastate.edu 515-294-3356

2. Econ 337, Spring 2014 Today’s Topic Livestock Pricing

3. Econ 337, Spring 2014 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 at a transaction price for a given quality and quantity of product at a given time and place.

4. Econ 337, Spring 2014 Price Determination  Supply determinants or factors affecting quantity produced  Input prices (feed, feeder cattle, weaned/feeder pigs)  Technology (growth promotants, etc.)  Expected price of outputs produced from inputs (finished cattle, finished hogs)  Demand forces or factors affecting quantity consumed  Prices of products produced (beef, pork)  Prices of competing products (chicken, turkey, beef, pork)  Consumer income  Tastes and preferences

5. Econ 337, Spring 2014 Price Discovery  A human process, subject to relative bargaining power of the buyer and seller.  Involves several interrelated concepts:  Market structure (number, size, location, and competitiveness of buyers and sellers),  Market behavior (buyer procurement and pricing methods),  Market information and price reporting (amount, timeliness, and reliability of information), and  Futures markets and risk management alternatives.  Two stage process  Evaluate supply, demand, and market prices.  Estimate the price for the specific trade.

6. Econ 337, Spring 2014 Price Determination and Price Discovery S D P Q PePe QeQe

7. Econ 337, Spring 2014 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

8. Econ 337, Spring 2014 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

9. Econ 337, Spring 2014 Important Market Functions  Assembly function  Feeder cattle  Cull cows  Sorting function  Feeder cattle grade and condition  Weight  Intended use/destination

10. Econ 337, Spring 2014 Decentralized Pricing  One-to-one negotiations + Reduced transportation cost + Reduced transaction cost - Depends on skills and information - Higher search cost

11. Econ 337, Spring 2014 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  Weaned and feeder pigs  Growing in feeder cattle where source verification is important

12. Econ 337, Spring 2014 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 ??????

13. Econ 337, Spring 2014 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

14. Econ 337, Spring 2014 Hybrid Markets  Electronic markets  Centralized pricing  Decentralized product movement  Examples  Satellite auctions  Electronic auctions  Tel-o-auction  E-commerce

15. Econ 337, Spring 2014 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?

16. Econ 337, Spring 2014 Cash/Spot market price Often through a broker USDA report Formula price Based on observable price Spot market Hog futures, maybe corn & SBM Example: 50% of 5-month-out LH futures

17. Econ 337, Spring 2014

18. Wean to Finish Pig Pricing Simulation 50% 5-month out LHF Seller’s Buyer’s Returns Returns Average $7.31 $3.03 Std Dev $5.68 $16.97 Minimum -$6.39 -$36.67 Maximum $18.91 $35.23

19. Econ 337, Spring 2014 Wean to Finish Pig Pricing Simulation 60% 5-month out LHF Seller’s Buyer’s Returns Returns Average $15.12 -$4.78 Std Dev $6.94 $16.11 Minimum -$2.83 -$44.00 Maximum $27.43 $27.56

20. Econ 337, Spring 2014 Wean to Finish Pig Pricing Simulation 70% 5-month out LHF Seller’s Buyer’s Returns Returns Average $21.58 -$11.24 Std Dev $6.90 $16.51 Minimum $1.71 -$51.33 Maximum $29.95 $24.74

21. Econ 337, Spring 2014 Performance Issues  “Least cost” method of price discovery  Effect of the mechanism on price behavior  Marketing vs. pricing efficiency

22. Econ 337, Spring 2014 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

23. Econ 337, Spring 2014 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

24. Econ 337, Spring 2014 Derived Demand Px Qx D farm D retail S P retail P farm Q D wholesale P wholesale Cuts of meat Carcasses Animals Vertical distance is the difference in price at 3 levels There is cost associated with moving from one level to the next

25. Econ 337, Spring 2014 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

26. Econ 337, Spring 2014 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 $/cwt.$82.50 (or think of it as ¢/lb.)

27. Econ 337, Spring 2014 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.

28. Econ 337, Spring 2014 Class web site: http://www.econ.iastate.edu/~chart/Classes/econ337/ Spring2014/