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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 P Pe D Qe Q 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? Feeder Pig Trade Spot market price Often through a broker USDA report Formula pricing Based on observable price Spot market Hog 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 S Vertical distance is the difference is price at 3 levels There is cost associated with moving from one level to the next Px Pretail Pwholesale Pfarm Dretail Cuts of meat Dwholesale Carcasses Dfarm Q Animals Qx 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.
