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Spatial Price Analysis –Physical Balance Equilibrium. Markets and Prices in Agribusiness AG BM 420. Arbitrage effects. Prices adjust across regions Product is moved……

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Spatial Price Analysis –Physical Balance Equilibrium

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## Spatial Price Analysis –Physical Balance Equilibrium

AG BM 420

### Arbitrage effects

• 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!

Pj = P1 + AC(Y1j )

### Thinking in terms of economic geographyEconomics tells us how to find the boundaries of an economic region!

Supply Region

P1 =AC(Y1)

Pk = P1 + AC(Y1k )

Trade past the green frontier is not profitable!

Pj = P1 + AC(Y1j )

### Spatial arbitrage – suppose there is a barrier to any trade

Source Region

Pj=AC(Yj)

Destination Region

Pi =AC(Yi)

Spatial arbitrage is not in equilibrium

Pi > Pj + AC(Yij )

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

### 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

### 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 = Ysti - Ydti = Yxti exports

Suppose region j has excess demand @ trade price

Excess demand = Yd ti - Ysti = Ymti imports

### Physical balance equilibrium

Excess supply = Ysti - Ydti = Yxti

Excess demand = Ydtj - Ystj = Ymtji

So since Exports = Imports

Yxti = Ymtji

Excess supply = Ysti - Ydti

= Excess demand = Ydtj - Ystj

### Physical balance equilibrium

Exports = Imports

Yxti = Ymtji

Ysti - Ydti = Ydtj - Ystj

We can re-arrange collecting supply on one side….

Ysti + Ystj= Ydtj + Ydti

 Total supply = Total Demand

### Physical balance implications for prices

Let’s add prices, remember Pi and Pj ….affect decisions……and lets ignore other drivers so

Ydti (Pit ) – Ysti (Pit )

= Ystj (Pjt ) - Ydtj (Pjt )

Interpretation? Simple…. The prices in the two regions Pit and Pjt are jointly determined

### Physical balance implications for prices

Ydti (Pit ,Ijt ,Djt ) – Ysti (Pit ,Rjt ,Kjt)

= Ystj (Pjt ,Rjt ,Kjt) - Ydtj (Pjt ,Ijt , Djt )

Interpretation? Simple…. The prices in the two regions Pit and Pjt are jointly determined by all the drivers affecting demand and supply in each region!

### Spatial arbitrage – suppose

Excess Supply Region

Excess Demand Region

Spatial arbitrage equilibrium condition

1) Pi = Pj + AC(Yij ) then product would be arbitraged from j to i

Physical balance condition across trading regions

2) Excess demandi (Pi )= excess supplyj ( Pj )

Together, 1) & 2)  Pi Pj Yij

### Bottom-line

• Arbitrage knits regions together binding the markets together such that

Physical balance is established

Ydti (Pit ,Ijt ,Djt ) – Ysti (Pit ,Rjt ,Kjt)

= Ystj (Pjt ,Rjt ,Kjt) - Ydtj (Pjt ,Ijt , Djt )

Arbitrage equilibrium in price is established

Pit = Pjt + ACijt

### 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

### 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?

### 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) Ydti (Pit ,Ijt ,Djt ) – Ysti (Pit ,Rjt ,Kjt)

= Ystj (Pjt ,Rjt ,Kjt) - Ydtj (Pjt ,Ijt , Djt )

Arbitrage equilibrium in price is established

2) Pi = Pj + ACij

### 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

### 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