1. Spatial Price Analysis – Physical Balance Equilibrium Markets and Prices in Agribusiness AG BM 420

2. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 2 Arbitrage effects Prices adjust across regions Product is moved…… We saw arbitrage results in an equilibrium condition a rule that always applies in competitive markets….that relate prices across prices. Arbitrage forces structure on prices! P j = P 1 + AC(Y 1j )

3. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 3 Thinking in terms of economic geography Economics tells us how to find the boundaries of an economic region! Supply Region P 1 =AC(Y 1 ) P j = P 1 + AC(Y 1j ) P k = P 1 + AC(Y 1k ) Trade past the green frontier is not profitable!

4. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 4 Spatial arbitrage – suppose there is a barrier to any trade Source Region P j =AC(Y j ) Spatial arbitrage is not in equilibrium P i > P j + AC(Y ij ) Why is this a problem? Region i would be paying more for the good then they need to if arbitrage were allowed…….Region i welfare would be reduced. Region j could supply region i but can’t so region j has reduced welfare Destination Region P i =AC(Y i )

5. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 5 Arbitrage forces physical balance Physical balance is the rule that within a trading area Excess demand = excess demand Total demand = total supply Prices adjust to make this happen

6. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 6 Physical balance equilibrium Recall, for a single market, we said quantities must balance across supply sources and types of utilization Suppose region i has excess supply @ trade price Excess supply = Y s ti - Y d ti = Y x ti exports Suppose region j has excess demand @ trade price Excess demand = Y d ti - Y s ti = Y m ti imports

7. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 7 Physical balance equilibrium Excess supply = Y s ti - Y d ti = Y x ti Excess demand = Y d tj - Y s tj = Y m tji So since Exports = Imports Y x ti = Y m tji Excess supply = Y s ti - Y d ti = Excess demand = Y d tj - Y s tj

8. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 8 Physical balance equilibrium Exports = Imports Y x ti = Y m tji Y s ti - Y d ti = Y d tj - Y s tj We can re-arrange collecting supply on one side…. Y s ti + Y s tj = Y d tj + Y d ti  Total supply = Total Demand

9. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 9 Physical balance implications for prices Let’s add prices, remember P i and P j …. affect decisions……and lets ignore other drivers so Y d ti (P it ) – Y s ti (P it ) = Y s tj (P jt ) - Y d tj (P jt ) Interpretation? Simple…. The prices in the two regions P it and P jt are jointly determined

10. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 10 Physical balance implications for prices Let’s add other drivers so Y d ti (P it,I jt,D jt ) – Y s ti (P it,R jt,K jt ) = Y s tj (P jt,R jt,K jt ) - Y d tj (P jt,I jt, D jt ) Interpretation? Simple…. The prices in the two regions P it and P jt are jointly determined by all the drivers affecting demand and supply in each region!

11. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 11 Spatial arbitrage – suppose Excess Supply Region Spatial arbitrage equilibrium condition 1) P i = P j + AC(Y ij ) then product would be arbitraged from j to i Physical balance condition across trading regions 2) Excess demand i (P i )= excess supply j ( P j ) Excess Demand Region Together, 1) & 2)  P i P j Y ij

12. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 12 Bottom-line Arbitrage knits regions together binding the markets together such that Physical balance is established Y d ti (P it,I jt,D jt ) – Y s ti (P it,R jt,K jt ) = Y s tj (P jt,R jt,K jt ) - Y d tj (P jt,I jt, D jt ) Arbitrage equilibrium in price is established P it = P jt + AC ijt

13. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 13 Important result Stuff (drivers) in export region affects prices in import region, and vice versa! Bad weather in Montana affects Montana hay price,…….but also the price of hay in PA! Hurricane in Nawlins affect plywood prices there and also those in PA! Unemployment in China affects hockey puck prices in the US

14. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 14 Practical implications Suppose you run a dry cleaning business in Williamsport, PA 30 minutes from State College Price for a shirt is low in Williamsport, and your plant has excess capacity Price of a shirt is 26% higher in State College. Should you open a home pick/delivery route in State College? At current prices? But what will happen to those prices as you shift service capacity to State College? What will happen to your Williamsport price if unemployment increases in State College?

15. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 15 Price determination We need to determine two prices, so we need two equations and we have ‘em! Physical balance is established Excess demand = Excess supply 1) Y d ti (P it,I jt,D jt ) – Y s ti (P it,R jt,K jt ) = Y s tj (P jt,R jt,K jt ) - Y d tj (P jt,I jt, D jt ) Arbitrage equilibrium in price is established 2) P i = P j + AC ij

16. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 16 In reality, spatial arbitrage involves multiple markets

17. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 17 Spatial geography of product flows

18. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 18 Practical implications Income increases in China  excess demand for Cement Plywood Flat screen tvs Motor scooters Automobiles Wheat Sugar  China’s import demand increases  increase exports from US  Increased prices in the US

19. (c) R.D. Weaver AGBM 420 Markets and Prices in Agribusiness 19 Implications for your product market Identify the most important regional markets linked by spatial arbitrage to your product’s market Set up a spreadsheet and collect & track  Supply & utilization quantity data for your market and each important spatially linked market  Prices for your product in your market & spatially linked markets  Drivers of demand and supply in your market & spatially linked markets Why does Walmart have cashiers ask you for your zip code when you check out??