Spatial Price Analysis – Module 2

Spatial Price Analysis – Module 2

Markets and Prices in Agribusiness

AG BM 420

(c) R.D. Weaver AGBM 420


2

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?



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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



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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



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Housing prices vary across neighboring states

Media Contact: Katherine Dibling, 215-574-4119, [email protected]



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2009



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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



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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



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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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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.



19

Similar results for most products~! Apple prices

Lancaster weekly market

vs. London weekly market?



20

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/



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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?



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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.



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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



27

Graph the prices Pa-Illinois Arbitrage? PA-Illinois CornGrain

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2000 2001 2002 2003 2004

$/b

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Illinois

PA

http://www.nass.usda.gov:81/ipedb/

What do you notice about the behavior of these prices?



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Graph of the spatial margin PA-Illinois CornGrain

0.25

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2000 2001 2002 2003 2004

$/b

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Basis


Basis responds to price transmission speed, what else?



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Graph the basis ~ Are there profits here?PA-Illinois CornGrainBasis

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Basis


Does positive basis mean profit?



30

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



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How can we explain this spatial structure in prices? PA-Illinois CornGrain

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2000 2001 2002 2003 2004

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Illinois

PA




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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.



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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



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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!



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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!



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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.



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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?



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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



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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



52

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 )



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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



54

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!



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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?



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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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Spatial Price Analysis – Module 2

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