Spatial Price Analysis – Module 2
Markets and Prices in Agribusiness
AG BM 420
(c) R.D. Weaver AGBM 420
Markets and Prices in Agribusiness
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Brief outline of module (see schedule) Overview of extent of spatial price variation
Over a set of spatial locations – regional, national At specific locations
Key questions Why do products flow from one place to another? Can we predict the direction of flows? Can we predict the quantity of flows? Can we predict and analyze the prices across locations?
(c) R.D. Weaver AGBM 420
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Let’s re-consider economics of the storyNew concepts
Spatial arbitrage Spatial equilibrium Exchange rate Arbitrage equilibrium Physical balance condition Trade distortions Barriers to trade Open vs closed economy
(c) R.D. Weaver AGBM 420
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What is the nature of spatial variation in prices? Think of your product
Where are the main supply sources located? Where are the main demand points located?
How does the product get moved from supply to demand points?
Why does it get moved?
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Regional aggregate prices
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Housing prices
http://www.philadelphiafed.org/index.cfm Affordability and Availability of Rental
Housing in Pennsylvania The Federal Reserve Bank of Philadelphia has
released Affordability and Availability of Rental Housing in Pennsylvania, a study that assesses the needs of lower-income renters.
http://www.philadelphiafed.org/community-development/publications/special-reports/rental-housing/
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Regional Economic Performance
Open vs closed economies
Why focus on regional performance?
http://www.philadelphiafed.org/research-and-data/regional-economy/
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Employment – Why regional differences?http://www.philadelphiafed.org/research-and-data/regional-economy/releases/employment/2009/MSANewsNov2009.pdf
(c) R.D. Weaver AGBM 420
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(c) R.D. Weaver AGBM 420
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Housing prices vary across neighboring states
Media Contact: Katherine Dibling, 215-574-4119, [email protected]
(c) R.D. Weaver AGBM 420
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2009
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(c) R.D. Weaver AGBM 420
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County level data
http://www.philadelphiafed.org/research-and-data/regional-economy/historical-data/
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Check out spatial variation of ag prices Illinois crop price data base FarmDoc
http://www.farmdoc.uiuc.edu/
Check it out!
Go to prices & weather………http://www.farmdoc.uiuc.edu/weatherprices/index.asp
(c) R.D. Weaver AGBM 420
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Crop regions in Illinois
region_ID region
1 Northern
2 Western
3 North Central
4 South Central
5 Wabash
6 West Southwest
7 Little Egypt
(c) R.D. Weaver AGBM 420
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Example of price variation at one location Illinois #2 Soybean Prices Weekly
http://www.farmdoc.uiuc.edu/marketing/soybeanCash.xls
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(c) R.D. Weaver AGBM 420
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Example: Prices across locations
Co-movement of prices due to spatial arbitrage
Illinois #2 Soybean Prices Weeklyhttp://www.farmdoc.uiuc.edu/marketing/soybeanCash.xls
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Illinois Region 1 #2 Soybean Prices Weekly
IllinoisRegion 2 #2 Soybean Prices Weekly
IllinoisRegion 3 #2 Soybean Prices Weekly
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Open vs closed economies
An open economy is a geographic space in which the economy (markets, firms, consumers) are linked other spatial locations through economic transactions.
Examples?
What is a closed economy?
We could say an economy is closed if there exist “barriers to trade” that prevent transactions between that economy and economies at other spatial locations.
(c) R.D. Weaver AGBM 420
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Similar results for most products~! Apple prices
Lancaster weekly market
vs. London weekly market?
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The spatial price difference
Consider PA vs Illinois Corn Grain
Lets get some data first
http://www.nass.usda.gov:81/ipedb/#http://www.nass.usda.gov:81/ipedb/
(c) R.D. Weaver AGBM 420
Markets and Prices in Agribusiness
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(c) R.D. Weaver AGBM 420
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Ok let’s get technical!
How can economics help us understand spatial price variation?
How can you use spatial price variation to better understand the price behavior at a particular spatial location?
(c) R.D. Weaver AGBM 420
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Definition – spatial marketing margin Suppose you can buy a product in one market and
sell it in another market, the difference in price would be a margin of revenue per unit (+ or -).
Def: Spatial marketing margin is the average revenue per unit that can be earned by moving a product from one spatial location (source market) to another (destination market).
mij = Pi – Pj where i is the destination market and j is the source
market
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Definition - basis
If one market is a central market, then the marketing margin between an outlying market and the central market is called “basis”
Usage? See if you can find an example of the use of “basis” in commodity press or for your product.
(c) R.D. Weaver AGBM 420
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Compute Spatial Marketing Margin Spatial margin can be
substantial and it clearly varies!
Illinois PA2000 Jan 1.97 2.62 0.65
Feb 2.03 2.57 0.54Mar 2.11 2.57 0.46Apr 2.02 2.55 0.53May 2.2 2.65 0.45Jun 1.89 2.47 0.58Jul 1.66 2.34 0.68Aug 1.54 2.14 0.6Sep 1.64 2.06 0.42Oct 1.8 1.89 0.09Nov 1.92 1.89 -0.03Dec 2.03 2.1 0.07
2001 Jan 1.97 2.18 0.21Feb 2 2.35 0.35Mar 2 2.3 0.3Apr 1.92 2.28 0.36May 1.86 2.31 0.45Jun 1.83 2.25 0.42Jul 1.95 2.38 0.43Aug 1.99 2.33 0.34Sep 1.94 2.32 0.38Oct 1.85 2.14 0.29Nov 1.91 2.22 0.31Dec 2.06 2.35 0.29
2002 Jan 2.01 2.35 0.34Feb 1.98 2.36 0.38Mar 1.98 2.36 0.38
Margin
(c) R.D. Weaver AGBM 420
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Graph the prices Pa-Illinois Arbitrage? PA-Illinois CornGrain
1.5
1.7
1.9
2.1
2.3
2.5
2.7
2.9
3.1Ja
nF
eb Mar
Apr
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2000 2001 2002 2003 2004
$/b
u
Illinois
PA
http://www.nass.usda.gov:81/ipedb/
What do you notice about the behavior of these prices?
(c) R.D. Weaver AGBM 420
Markets and Prices in Agribusiness
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Graph of the spatial margin PA-Illinois CornGrain
0.25
0.3
0.35
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0.45
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Fe
bM
ar
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rM
ay
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ep
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ar
2000 2001 2002 2003 2004
$/b
u
Basis
http://www.nass.usda.gov:81/ipedb/
Basis responds to price transmission speed, what else?
(c) R.D. Weaver AGBM 420
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Graph the basis ~ Are there profits here?PA-Illinois CornGrainBasis
-0.05
0.05
0.15
0.25
0.35
0.45
0.55
0.65
0.75
Jan
Feb
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2000 2001 2002 2003 2004
$/b
u
Basis
http://www.nass.usda.gov:81/ipedb/
Does positive basis mean profit?
(c) R.D. Weaver AGBM 420
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Compute Spatial Marketing Margin Spatial margin can be
substantial and it clearly varies!
Illinois PA2000 Jan 1.97 2.62 0.65
Feb 2.03 2.57 0.54Mar 2.11 2.57 0.46Apr 2.02 2.55 0.53May 2.2 2.65 0.45Jun 1.89 2.47 0.58Jul 1.66 2.34 0.68Aug 1.54 2.14 0.6Sep 1.64 2.06 0.42Oct 1.8 1.89 0.09Nov 1.92 1.89 -0.03Dec 2.03 2.1 0.07
2001 Jan 1.97 2.18 0.21Feb 2 2.35 0.35Mar 2 2.3 0.3Apr 1.92 2.28 0.36May 1.86 2.31 0.45Jun 1.83 2.25 0.42Jul 1.95 2.38 0.43Aug 1.99 2.33 0.34Sep 1.94 2.32 0.38Oct 1.85 2.14 0.29Nov 1.91 2.22 0.31Dec 2.06 2.35 0.29
2002 Jan 2.01 2.35 0.34Feb 1.98 2.36 0.38Mar 1.98 2.36 0.38
Margin
(c) R.D. Weaver AGBM 420
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How can we explain this spatial structure in prices? PA-Illinois CornGrain
1.5
1.7
1.9
2.1
2.3
2.5
2.7
2.9
3.1Ja
nF
eb
Ma
rA
pr
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yJu
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lA
ug
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pO
ctN
ov
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cJa
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pr
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ug
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ctN
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Ma
yJu
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lA
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Se
pO
ctN
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De
cJa
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eb
Ma
r
2000 2001 2002 2003 2004
$/b
u
Illinois
PA
http://www.nass.usda.gov:81/ipedb/
(c) R.D. Weaver AGBM 420
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What makes multiple markets work?We need three types of agents
Consumers in each Producers in each Arbitragers to knit the markets together
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Arbitrage - Review of conceptDefinition
Arbitrage is the economic function of taking a product from one market to another for a profit. Sometimes product transformation occurs, but always product attributes change at least with respect to location, time, etc.
(c) R.D. Weaver AGBM 420
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Types of Arbitrage
Arbitrage can move products Spatially Vertically Horizontally Over time
How?
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Arbitrage as an economic function Demand Supply Arbitrage
Competition Equilibrium
Balancing of demand and supply via price adjustment
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Notation
Suppose we have two markets, #1 and #2 One product, lets use the symbol Y to indicate the
quantity of that product, and P to indicate its price.
We will use subscripts to indicate in what market we are measuring the quantity or price.
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Define the profits from arbitrage
)( 1212112212 YCYPYP
Step 1: Determine the direction of product flow
Look at the prices, PA > Illinois suggests product flow from Illinois to PA Define region 1 as Illinois
Step 2: Define profits from spatial arbitrage
(c) R.D. Weaver AGBM 420
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Now, suppose we have competition!
)(
0)(/
0)(
_
1212
12121212
1212112212
YACPP
YACPPY
YCYPYP
entryfreearbitrage
Using the notion of competition, and free entry, we can establish some important implications of spatial arbitrage!
• Arbitrage profits will attract entry
• Entry will drive profits to zero
• With profits at zero, prices in the two markets are bound together!
(c) R.D. Weaver AGBM 420
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Spatial arbitrage + competition establishes a systematic spatial structure in prices
)(
0)(/
0)(
_
1212
12121212
1212112212
YACPP
YACPPY
YCYPYP
entryfreearbitrage
Importantly, the last line defines a spatial structure in prices! The price in the two regions will be inextricably bound together by arbitrage + competition.
Arbitrage is the glue that binds markets together!
(c) R.D. Weaver AGBM 420
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How fast does spatial arbitrage happen? What happens when a hurricane strikes?
Price of plywood in strike zone goes up Agents outside of the strike zone see profits and load their trucks! Price is driven down in the strike zone
Ethics of arbitrage……….If we do not have adequate arbitrage, substantial price swings may
occur ……….and persist.
Social role of arbitrage
Spatial arbitrage plays an important role in stabilizing prices over time and ensuring access to products.
(c) R.D. Weaver AGBM 420
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Arbitrage is driven by profitsConsider the simple case, suppose two regions i, j
with prices, Pi , Pj
Three questions are of interest: 1) In which direction will arbitrage (trade) carry the
product?2) What will be the effect of spatial arbitrage?
1) Price effects2) Quantity moved (traded)
3) Can we predict the price in one region, with the prices of another?
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The problem of where to sell…Suppose supply is located at the green dot, say
coffee….and demand (orders) are received from tan dot locations. How should the producer allocate supply to these points?
(c) R.D. Weaver AGBM 420
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What if………there were topography?
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What if………there were political borders with walls or taxes?
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Profits drive arbitrage…
define spatial arbitrage profits
Profits(i,j) = Pei dij Yij - PjYij - AcijYij
Pei price you hope to receive in market i i.e. it is our expected price
dij proportion left after deterioration in physical quantity due to shipping
Yij quantity purchased in jth & shipped to ith market
Acij unit cost of shipping
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Get some real data on costs
Add a column to your spreadsheet to compute profits
Unit cost of transp 0.22
Ill-PAIllinois PA Spatial
MarginProfits
2000 Jan 1.97 2.62 0.65 0.43Feb 2.03 2.57 0.54 0.32Mar 2.11 2.57 0.46 0.24Apr 2.02 2.55 0.53 0.31May 2.2 2.65 0.45 0.23Jun 1.89 2.47 0.58 0.36Jul 1.66 2.34 0.68 0.46Aug 1.54 2.14 0.6 0.38Sep 1.64 2.06 0.42 0.2Oct 1.8 1.89 0.09 -0.13Nov 1.92 1.89 -0.03 -0.25Dec 2.03 2.1 0.07 -0.15
2001 Jan 1.97 2.18 0.21 -0.01Feb 2 2.35 0.35 0.13Mar 2 2.3 0.3 0.08Apr 1.92 2.28 0.36 0.14May 1.86 2.31 0.45 0.23Jun 1.83 2.25 0.42 0.2Jul 1.95 2.38 0.43 0.21Aug 1.99 2.33 0.34 0.12Sep 1.94 2.32 0.38 0.16Oct 1.85 2.14 0.29 0.07Nov 1.91 2.22 0.31 0.09Dec 2.06 2.35 0.29 0.07
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Question #1: In which direction will arbitrage (trade) carry the product?
We can answer this just by recognizing that:
Arbitrage will not occur if it is not expected to be profitable
Profits(i,j) = Pei dij Yij - PjYij - Acij*Yij 0 ?
If so, then arbitrage will carry the product from region j to region i.
If not, then flow from region j to region i = 0
(c) R.D. Weaver AGBM 420
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Question #1: In which direction will arbitrage (trade) carry the product?
Check both directions………………
Profits(j,i) = Pei dji Yji - PiYji - Acji*Yji 0 ?
If so, then arbitrage will carry the product from
region i to region j.
If not, then flow from region i to region j = 0
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In the real world
Flow direction may change over time!
Why?
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Spatial equilibrium – how everything balances out
In a single market, price is determined by demand =supply.
When we have multiple spatial markets interacting, life gets a bit more complicated!
Lets keep our focus on two market case
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Question #2: What will be the effects of spatial arbitrage?
If profits exist, competitive entry drives profits to zero! Flow expands until …..
Profits(i,j) = Pei dij Yij - PjYij - Acij*Yij = 0
(we can divide through by Yj , why does nothing change?)
Price effect
Competition arbitrage locks prices together across locations
Peit dij = Pjt + ACij
(c) R.D. Weaver AGBM 420
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But, arbitrage moves product from one market to another, what happens to demand and supply? Quantity of trade?
If profits exist, competitive entry drives profits to zero! Flow expands until …..
Profits(i,j) = Pei dij Yij - PjYij - Acij*Yij = 0
Spatial equilibrium defines the quantity traded as the Yij that solves
Peit dij = Pjt + ACij (Yij )
(c) R.D. Weaver AGBM 420
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Application: Where to sell?
)Y(ACPP
againonce
)Y(CYPYP
wherejmarketsallointSell
)Y(CYPYP
ifmarketinlocallySell
jj
jjjjj
11
11111
1212112212
0
0
1
(c) R.D. Weaver AGBM 420
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Competition drives prices to equal average costLinking production and spatial market decisions
Remember, competitive entry into production also drives profits to zero
2)
0
00
1111
11111
)Y(ACPY/
Y|)Y(CYP
)Y(AC)Y(ACP
)Y(ACPP
jj
jj
11
11
So, spatially we have
Using 2) above, we have
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Thinking in terms of economic geographyEconomics tells us how to find the boundaries of an economic region!
Supply Region
P1 =AC(Y1)
Pj = P1 + AC(Y1j )
Pk = P1 + AC(Y1k )
Trade past the green frontier is not profitable!
(c) R.D. Weaver AGBM 420
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In the real world, where is that frontier? Consider your product
Where are the top geographic points of supply? Where are the main regions where product is
demanded? For each supply point, or region, to where should it sell
its product? Consider prices of your product across different
regions, are they related?
(c) R.D. Weaver AGBM 420
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Conclusions
Spatial arbitrage will drive the price for a good in different regions into a relationship that reflects cost of moving the good from one region to another.
We can use prices in one region to predict prices in another region!
Spatial arbitrage ends up defining an economic map of the spatial market.
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