Expectations, reservation demand and the stability of agricultural markets

Abstract

Graduation date: 1985The distribution of agricultural production for\ud continuous consumption requires the capacity to maintain\ud inventories which are large relative to the rate of\ud utilization. As a result, the demand for inventories is a\ud critical element in the pricing of agricultural\ud commodities. A component of inventory demand, referred to\ud here as reservation demand, is sensitive to expectations\ud for future prices and may be a significant source of price\ud instability in agricultural markets. Price expectations\ud are, in part, dependent on current price information.\ud This creates a potentially complex and volatile pricing\ud structure.\ud A cusp catastrophe with slow feedback is used to\ud model the interrelationship between the formation of\ud expectations and price determination. A catastrophe model\ud allows the use of relatively unrestrictive assumptions\ud concerning the formation of expectations and provides a\ud picture of how unstable price behavior can exist within a\ud structurally stable pricing system.\ud Some of the concepts underlying catastrophe theory\ud are presented in the familiar context of a competitive\ud market. This is followed by a demonstration of how\ud speculative changes in the demand for inventory may\ud disrupt the pricing structure of a competitive market. A\ud cusp catastrophe model of a competitive market for a\ud stored commodity is developed.\ud Simulation experiments are conducted to demonstrate\ud how alternative forms of price behavior can be represented\ud within the model. Prices generated by the model are\ud compared to actual patterns of price adjustment observed\ud for wheat. An empirical investigation of the pricing\ud structure of the wheat market is then conducted. It is\ud concluded that the relationship between price expectations\ud and the demand for inventory is, at times, a source of\ud price instability for stored commodities. Speculative or\ud transitory changes in the demand for inventory tend to\ud exacerbate existing variability in agricultural prices.\ud This appears to be an important consideration in analysing\ud production and marketing alternatives and in evaluating\ud public policy. A cusp catastrophe with slow feedback\ud provides a good conceptual framework for taking the\ud interdependence of expectations and prices into account