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100 Cards in this Set

  • Front
  • Back
Cite 3 Significant ways the government affects price discovery process
Facilitate Price Discovery
Stabilize Market Prices
Correct Market Failure
Name 3 types of market failure and give an example of each
1. Monopolies: exist when a single, large firm dominates a given market : restrict output and drive up prices

2. Public Goods: goods that are non-excludable and non-rival in consumption : Food assistance to disadvantaged children

3. Externalities: goods which the full social cost or benefit of the good is not reflected in the market price consumers must pay : nitrogen fertilizers, honey bee farmers (apiculturalsts)
Invisible Hand
Correcting market failure
Self-regulating aspect of free markets
17th century Adam Smith
Price supports exist for what major crops?
Wheat, feed grains, rice, tobacco, peanuts, cotton
Butter, cheese, dried milk
Price Supports
(category of stabilize market prices)
policies designed to maintain minimum market prices

EX: price support method in US = non-recourse loans made by commodity credit union (CCC)

Allow farmers to store their commodities (grains) on-site until prices-rebound

Donations to school lunches
Production Controls
(category of stabilize market prices)
Seek to moderate market supplies (outputs) of Ag commodities

US programs that limit production of major farm crops

EX: acreage restrictions (tobacco quotas)
What are the 2 categories of Stabilizing Market Prices
Production Controls
Price Supports
What are the 3 main economic sectors?
Services
Industrial
Agriculture
Facilitating Price Discovery
Gov's often gather and distribute info about market transactions to encourage greater price efficiency

EX: 1999 Mandatory Livestock Reporting Act
Imposed greater price reporting requirements of meat packers

Helped to shift livestock price discovery away from marketing contracts and back again toward spot market transactions
What 3 ways that governments affect (interfere) the price discovery process?
1. To facilitate price discovery
2. To stabilize market prices
3. Correct market failure
Name 4 primary factors that affect the likelihood that individual farms will engage in contracting (5)
1. Scale economy benefits
2. Capacity requirements
3. Spot Market Efficiency
4. Identify preservation
5. Public Policies
What is the difference between price determination and price discovery?
Price determination: most theoretical process of equating supply and demand and calculating market equilibrium

Price discovery: the process or set of tools that buyers and sellers use to identify and agree on prices and other terms of exchange
3 Current trends in commodity grading?
1. Increasingly used as strategic marketing tool to aid product differentiation

2. Focuses on increase on process-based rather than outcome-based (interested in how food is produced- fresh, organic, $$)

3. Increasingly firm specific
2 requirements of grade standards?
Based on measurable attributes that are recognized by consumers

1. physical characteristics - prime beef

2. how it is produced - organic VS non-organic

Categorize output and inform customers
Absolute Auction
Do not include a reserve price

Attract greater # of interested buyers - hoping for a bargain price
What type of contract do farmers retain ownership of the commodity?
Marketing Contract
For what types of commodities are prices typically discovered using production costs?
Livestock
Cash/Spot Market
Venues in which buyers pay cash to sellers for the immediate transfer of goods or services

EX: grocery store, road-side vegetable market
Market Intermediaries
Livestock assemblers who bundle together many smaller lots to meet the terms of a standardized commodity exchange contract
Price discovery
A set of tools that buyers and sellers use to identify and agree on prices and other terms of exchange
Price determination
Equilibrium price determined by interaction of supply and demand

Mostly theoretical
English Auction
Open Ascending price auction

Bid against each other with each bid getting higher than the next

EX: Cattle and thoroughbred auctions
Dutch Auction
Open descending price auction

Asking price starts increasing and is decreasing until someone agrees to buy an item
Sealed Bid Auctions
All participants bid only once, at the same time, and without knowledge of other participants bids.

The highest bid offer wins

EX: Construction Contract Work
Reserve Price Auction
If the highest bid is below the undisclosed price, the auction is void and no exchange occurs.

No reserve price
Absolute Auctions
Name 3 features that make auctions more efficient price discovery mechanisms?
to be efficient price discovery mechanisms, auctions require competitive bidding process

1. Many bidders
2. Bidding frequently
3. Bidding autonomously
3 general types of price patterns
1. Seasonal price fluctuations (price cycle)
-Grain price lowest at Harvest

2. Multi-year cycles
-Cattle Cycle

3. Price Trends
-tied to demographics, welfare, environment
-rising incomes
Name the distinguishing characteristic of an auction
Rules vary based on type of auction and in accordance with needs of various participants
7 benefits of commodity grading standards
1. Allow customers to buy products unseen

2. lowers transaction costs

3. motivate producers to improve quality and safety

4. Facilitate price/quality comparisons

5. Reduce marketing risks

6. Facilitate dispute resolution

7. Enable alternative price discovery mechanisms
What are the governments primary tools for correcting market failure?
1. Regulation

2. Taxation

3. Subsidies
How does the government regulate Monopolies in regards to correcting market failure?
Gov regulates monopolies to restrict their formation (anti-trust regulations) or to control prices (local water companies)
How does the government tax for public goods in regards to correcting market failure?
Gov tax community members to pay for socially desirable but under provided goods
How does the government deal with subsidies in regards to correcting market failure?
Gov seeks to tax goods with negative externalities (that cause pollution) and subsidize goods with positive externalities (those goods that benefit society)
When do government policies tend to be approved most?
When benefits of the proposed policy are concentrated and costs are diffuse
Explain the role that transaction costs play in the likelihood that any particular government subsidy proposal (to help former tobacco growers transition to alternative crops) will be approved
Tend to be approved most easily when benefits of the proposed policy are concentrated and costs are diffuse.

Relatively high transaction costs may discourage the masses from mounting organized oppositions when individual payoffs are relatively low.

If in favor, the transaction costs are relatively low and the potential payoff relatively high.

For this reason, many governments heavily subside agricultural production in which highly organized farms garner most of the benefits while consumers and taxpayers pay most of the costs

EX: guarding domestic food security, ensuring affordable food, and preserving rural landscapes
Free Rider
Enjoy goods or services but do not pay and cannot be excluded for not paying

Free riders make it hard for private individuals and private markets to provide socially optimal quantity of these goods and services
What is the number one factor driving increased contracting?
The prospect of lower per unit costs (ATC) through increased scales of production
What is a second factor affecting contracting?
The capacity that processors and farmers must operate to maintain normal returns on their investments
What is the 3rd factor affecting contracting?
The relative efficiency of other price discovery mechanisms
What is the 4th factor affecting contracting?
Government policies
What does contracting do?
Contracting links buyers and sellers together through a more direct and less risky price discovery process
Production Contracts
Focus on those services that farmers will provide for contractors who retain ownership of commodities during production.

Also specify how the farmer will be compensated and the quantity and type of inputs the contractor will supply

EX: livestock contract - farmers may provide labor, housing, and equipment while contractors provide other inputs such as feed, veterinary, livestock transportation services, and young animals

-Fee paid for specific farming services
Marketing Contracts
Focus on when, how much, and what kind of commodity farmers will deliver to contractors rather than on the services farmers provide

-Famers retain ownership of their commodities during production and thus control major farm management decisions with limited direction from contractors.

-Use pricing formulas to compute eventual exchange prices.
What sort of price discovery mechanism typically uses a price formula with "base prices" and "adjustment factors"?
Price Formulas under Marketing Contracts

EX: Meat packer might agree in advance to pay a hog producer the average cash market price on a designated delivery date plus a two-cent per-pound premium.
What are the primary differences between production and marketing contracts (with respect to who owns the commodity, how autonomous farmers are to choose production practices, and the basis for compensation)?
Production contracts - contractor owns commodities, Farmers and buyers of their products increasingly agree formally and privately on terms of exchange prior to harvest, or in case of livestock, prior to completing production, fee paid for specific farming services

Marketing contracts : farmers own commodity, control major farm management, and its a market-based payment
By trading futures contracts on commodity exchanges, farmers and processors can easily transfer their price risk to market experts or to other buyers and sellers in a process called
Hedging
What is an example of hedging?
At planting time Midwestern Faerms estimates her production expenses $3/bushel expecting 5,000 bushel corn crop.

The current futures price for December delivery is $3.60/bushel and her delivery expenses are $0.40/bushel.

She can either take her chances that spot market corn prices at harvest time will increase, or she can HEDGE (lock in the acceptable price now and transfer price risk to speculators)
How do you hedge?
Begin planting and at the same time deposit the required margin with her broker with instructions to sell a December futures contract for corn at the current market price


With a locked-in price on her futures contract, the farmer is in a good position to demand an equivalent or better deal from the local elevator.
What are the 2 keys to understanding hedging?
1. Hedging is a risk-management strategy and not a profit-enhancing strategy

2. To neutralize price volatility, hedgers must have equal and opposite positions in the cash and futures markets
Speculator
Market Experts
Margin Call
A demand for the buyer to deposit more money into the margin account
The number one factor driving increased contracting is the prospect of lower per unit costs through increased ___________
scales of production
Which government intervention seeks to moderate market supplies of agricultural commodities directly?
Production Controls
Price Supports
government intervention (tool) designed to maintain minimum market prices
T/F Price supports for perishable crops or for major livestock products do not currently exist in the United States
True
In order to give market participants more assurance that the prices they agree to are closer to the competitive ideal, governments
gather and distribute information about market transactions
Commodities accumulated under US nonrecourse loan programs are not distributed to
brokers and dealers on spot market exchanges
Commodities accumulated under US nonrecourse loan program are distributed via non-competing channels mostly as free or subsidized food aid. why does the government not sell the commodity back into traditional marketing channels?
doing so would only push agriculture commodity prices lower
Which government intervention is designed to maintain minimum market prices
CCC
Production and marketing contracts are generally ________ transactions and are therefore _________ most spot markets exchanges
formal/written + unlike
T/F the primary factor that explains why contracting has increased so dramatically in the US tobacco industry since 1998 is the governments elimination of marketing quotas that previously controlled supply
True
crop farms are most likely to use _________ contracts
Marketing
unlike most forward contracts, production contracts specify details about how crops will be grown or livestock will be raised and they are typically __________
Multi-year agreements
Which of the following is NOT one of the four primary factors affecting the likelihood that individual farms will engage in contracting
Consumer demand
Production and marketing contracts are generally ______ transactions and are therefore ________most auctions
Private + Unlike
Marketing contracts are most like ________except that marketing contracts are more typically multi-year agreements
Forward Contracts
T/F Larger firms tend to contract more than smaller firms
True
Compared to futures contracts, custom forward contracts generally expose farmers to greater risk from all of the following except ________
Price fluctuations
T/F Futures contracts are standardized so that all that buyers and sellers have left to negotiate is the exchange price
True
T/F Hedging is generally a profit enhancing strategy while speculating is generally a risk-management strategy
False
Which is not a current trend with respect to commodity grade standards
They are focused on outcome-based rather than process-based standards
While grade standards can allow consumers to buy products, unseen, they generally do not help lower transactions costs
False
The attributes used to categorize output using grade standards may relate most generally either to a product's physical characteristics or how it was _________
produced
Grade standards serve two roles: they categorize output and ________
inform consumers
Marketing orders may become binding on all firms in a given market area if at least ________ of producers by volume in that area approve the order
2/3
In the US the USDA recognizes ______ grades for cotton
38
In the US the USDA recognizes _____ grades for eggs
3
In the US, the USDA recognizes _____ grades for beef
8
T/F Price discovery tends to be more efficient when auctions are more competitive
True
Also called a "cash market" a __________ market is one where buyers agree to pay cash to sellers for the immediate transfer of goods and services
Spot market
T/F To enhance the efficiency of price discovery, large commodity exchanges allow buyers and sellers to trade only pre-determined quantities of commodities using standardized contracts
True
T/F In most cases, price discovery reveals not only the market price but also other terms of exchange (delivery dates and locations)
True
T/F Auctions that require trades to be settled immediately in cash are technically specialized spot-markets
True
T/F Sealed first price auctions requires all participants to bid only once, at the same time, and without knowledge of other participants bids
True
SInce 1845, the real prices of industrial commodities have tended to be higher during which of the following periods?
during wartime (WWI,WWII)
T/F Auctions with reserve prices tend to attract the greatest number of potential bidders
False
T/F A roadside vegetable stand is a good example of a spot market
True
Name three general types of price patterns often observed in agriculture and give one example of each
1. Price fluctuations (seasonal- price cycle)

2. Multi-year cycles (cattle cycle)

3. Price trends (demographic, environmental, welfare changes)
Auction Markets
Buyers and sellers discover prices following specialized negotiation or bidding rules
Marketing Orders
Use mandatory standards to elevate consumer expectations (with respect to produce quality and safety) and thus bring price stability to unpredictable (fruit and vegetable) markets.

-Become binding on all individual firms in a specific geographic area (2/3 by volume)
Name and describe three reasons why private firms are developing their own commodity standards)
1. To create a reputation of greater quality assurance among consumers vis-a-vis rival firms.

2. To penetrate and/or develop niche markets earlier, more easily, and at a lower cost

3. To raise transaction costs and entry barriers for potential competitors
T/F Because futures contracts are securitized and standardized except for price, they have very low transaction costs compared to custom forward contracts.
True
When compared with custom forward contracts, futures contracts help reduce credit, legal, and cost risks. Explain How.
Transaction costs are so low that futures contracts are easily tradable. All are designated for exchange for a set period of time after which the commodity must be paid for or delivered unless an equal and opposite promises have been made.
When a farmer sells a futures contract what 2 options do they have?
1. Deliver the commodity as promised on the set delivery date.

2. He can "offset" the amount he will be short by buying an equivalent futures contract from another seller
T/F Marketing orders may reduce competition, reduce consumer choice, and lead to higher market prices.
True
T/F Marketing orders often require investments in new equipment, training, and costly changes in production practices
True
Forward Contract
A seller's promise to deliver a particular asset to a buyer at a set time in the future for a predetermined price.
T/F Forward contracts permit farmers to lock in prices for their planned harvest early in the growing season, store it on-site after harvest, and deliver it to buyers when and where buyers want it.
True
T/F As price discovery mechanisms, forward contracts work most efficiently and effectively when coupled with a well-functioning futures market ("futures exchange") where speculators and producers buy, sell, and trade futures contracts publicly
True
Futures Contract
A special type of forward contract that is standardized, tradable, and securitized