6.9 Buffer Stock Schemes and Market Failure Flashcards
What are buffer stock schemes?
Buffer stock schemes can be used by governments to keep commodity prices stable, protecting producers from low prices and consumers from high prices, given price volatility in the free market. The government does this through regular intervention in the market, buying up excess stocks produced when the price is too low and selling its own reserves of excess stocks when the price is too high
How do buffer stock schemes work?
Buffer stock schemes work by setting a maximum price to protect consumers on low incomes from prices rising excessively and a minimum price to protect producers from prices falling excessively thus maintaining their living standards. Prices are allowed to fluctuate between the bands but are not allowed to permanently remain above the maximum price or below the minimum price. Governments buy stocks when prices are too low, and release stocks onto the market when prices are too high.
What is the purpose of buffer stock schemes?
The purpose of buffer stock schemes is to maintain stable commodity prices, protecting producers from low prices and consumers from high prices, given price volatility in the free market. This policy can solve a market failure on the grounds of inequitable free market outcomes.
Figure 1 - Falling Pressure
Buffer Stock Scheme Diagram Analysis
- If the price of a commodity came under falling pressure as Figure 1 shows with supply shifting to the right from S1 to S2 perhaps due to a bumper harvest, a price fall from P1 to P2 would not be allowed harming the livelihoods of producers. The government would step in buy some of the stock in the market increasing demand for the commodity from D1 to D2 pushing the price back up to P1 within the permitted bands. The government would store the stock and release it onto the market if ever the price rose too high.
Figure 2 - Rising pressure
Buffer Stock Scheme Diagram Analysis
- If the price of a commodity came under rising pressure as Figure 2 shows due to demand shifting to the right from D1 to D2, a price rise from P1 to P2 would not be allowed harming the living standards of consumers who may not being able to afford this staple. The government would step in and sell stocks of the commodity it has stored up in the market increasing supply for the commodity from $1 to 52 pushing the price back down to P1 within the permitted bands. Selling stored stock allows the government to earn income to buy excess stock when the price falls too low.
- Periodic intervention like this allows the government to manipulate commodity prices, keeping them within the permitted bands, protecting the living standards of both consumers and producers thus solving a market failure on the grounds of inequitable free market outcomes.
Con: Maintaining a buffer stock scheme is very expensive
Cons/Eval
Maintaining a buffer stock scheme is very expensive. In theory governments selling stock when the price is too high and buying stock when the price is too low will generate surplus income to ensure the funding of this scheme is sustainable. However storing commodities is highly costly as is regularly buying up of excess stock if there have been bumper harvests. There is a large opportunity cost especially for developing countries where government revenue is low. This money could have spent more productively in other areas of the economy to promote development, perhaps in promoting diversification to get at the root of the problem of over specialisation in developing countries. Taxes may be high to fund this policy burdening consumers and those on low incomes. If the costs of the policy outweigh the benefits, there will be government failure.
Con: Buffer stock schemes are very difficult to maintain
Buffer stock schemes are very difficult to maintain. This is especially true if weather fluctuates from one year to the next generating runs of good and bad harvests. This implies the government will have to regularly intervene to buy up huge levels of stocks when harvests are good and sell huge levels of stocks when harvests are bad. The volumes needed to buy and sell are so large in order to change the world market price of a commodity that governments may simply not be able to do it. Perhaps they run out of stock to sell when the price is too high or lack the funds necessary to buy stock to increase the market price when the price is too low. In this case, the scheme will completely collapse.
Con: Buffer stocks schemes may not be possible for some primary commodities.
Buffer stocks schemes may not be possible for some primary commodities. This is because some primary commodities, such as agricultural goods, deteriorate too quickly to be stored. This means having enough stock to release onto the market when prices are too high is not possible. The costs of this policy would be too high without generating enough income to keep funding it - the system would fail.
Con: It is difficult to set the correct maximum and minimum price.
It is difficult to set the correct maximum and minimum price. This is because an equitable price for consumers and producers is a normative judgement and therefore easy to get wrong whereby the scheme becomes too difficult to maintain. For example if the minimum price to protect producers is set too high, the government will have to buy huge volumes of stock almost every time the price falls in the market which is not sustainable given the cost involved. Similarly if the maximum price to protect consumers is set too low the government will have to sell huge volumes of stored stocks almost every time the price rises in the market which is not feasible given the cost of storage and they expiration time of some commodities. However if the maximum price is set too high and minimum price set too low, the intention of the policy to protect consumers and producers will not be met with government failure the result.
