Price Variation through Time

 study models of price determination that seeks to explain

persistent patterns of price behavior through time.
 To provide an understanding of why temporal changes
occur and to help identify regularities in price behavior.
Components
1. Trends (T) – the gradual upward or downward movement of
price over time.
2. Seasonality (S) – the pattern of price fluctuations above or
below the trend line that occurs every year (12-months).
 This is the most common regularity in the price of
agricultural commodities.
e.g. prices of storable commodities such as rice are lowest
at harvest time and then rise as the season
progresses, reaching a peak prior to the next harvest.
3. Cycles (C) – patterns in the price data that occur every several
years; usually tied with the business cycle.
 Price cycles for agricultural commodities tend to vary in
length and in amplitude, but there exists a clear tendency
for them to expand in response to favorable prices, which in
turn leads to lower prices in a subsequent period.
4. Random Variations (R) – “blips” in the price data caused by
chance and unusual situations; they follow no discernible
pattern.
 Reliable estimates of the future can be made only insofar as
seasonal patterns, trends, or cycles persist in uniform manner.
 Changes in government programs, a severe drought, or a new
international crisis can create irregular price movements which
are impossible to forecast.
AECO 122 Lecture Note: Nora DM. Carambas Page 1
A. Short Time Price Variation
As negotiations and trades take place among buyers and sellers,
specific prices are obtained.
 Prices may change from week to week, from day to day, and
even within a trading day.
Factors Influencing Current Prices
1. Current changes in supply and demand
 Day-to-day variation in demand is usually less volatile than
in supply.
2. Expected changes in factors affecting prices
e.g. expected changes in government price-support or export
programs, anticipated oil price hike, anticipated dock
strike which would reduce exports.
Prices for some agricultural products are established within
institutional framework tending to eliminate daily price changes,
e.g.,
1. Contracts – negotiated by sellers and buyers with price fixed
by a formula or by prior agreement.
2. Futures
The changing structure of agriculture (more specialized, larger
scale, stable production and marketing) and in marketing
arrangements results in less frequent price changes today than in
the past.

B. Seasonal Variations in Price

Seasonal price behavior
 a regularly repeating price pattern that is completed once
every twelve months.

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Price

Time
12 months 12 months

Sources of Seasonality
1. seasonality of demand
2. seasonality of supply and marketing,
3. combination of the two.
 Most agricultural products are characterized by some
seasonality in agricultural production and marketing patterns.
 For crops, it is due to climatic factors and biological
growth process.
 For livestock and livestock products, it is due to seasonal
variation in climatic conditions, seasonality of feed
supplies, and the biological character of the production
process.
e.g., many crops are harvested once a year and, depending on
perishability, may be stored for sale through a marketing
season.
 Seasonality in demand also exists for agricultural products and
is related to factors like climate and holidays, e.g.,
 Demand for cutflowers is closely associated with certain
holidays (Valentine’s Day, All Saints’ Day).
 Demand for turkey in the US is closely associated to the
Thanksgiving and Christmas holidays.

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 P S3
S2

P3 S1
P2
P1

0 Q/t

A model of seasonal supply and seasonal price change

Assumptions:
1. The year consists of three seasons.
2. Crop is harvested in Season 1.
3. Demand is the same for each season.
Since producer-inventory holders have a choice of selling at harvest
of or holding inventory, S1 and S2 are positively sloped.
The slopes become progressively steeper for the successive
seasonal supplies,
 Higher prices are required in the successive seasons to
induce inventory holders to carry inventories.
 Seasonal price increase must cover storage costs.
 As time passes, the range of alternatives open decreases.
 Inventory carried in Season 3 must be sold in that season
and cannot be carried over into the new crop year.

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 The “Normal” Seasonal Pattern
 The usual price pattern for a seasonal crop (harvested within brief period
but then sold throughout the year) is for the price to rise through the
year as a function of the cost of storing the commodity.
 The product is allocated by the relationship of current and expected
prices to storage costs.
 The price change must be sufficient enough to induce some to sell
and other to store.
 The price declines rather abruptly to the next seasonal low.
 A merchant stores a commodity if he or she expects the benefits from
storage to equal or exceed the costs of storage.
 In equilibrium, in a perfect market:
Pf - Pc = M
Where: Pf – expected future price
Pc – current price
M – cost of storage

P2

Cost of storage from t1 to t2

P1

0 t1 t2 Time

where t1 – harvest season

t2 – end of season

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 P

0 12 months 12 months Time

Components of Cost of Storage

1. Cost of warehouse space
2. Fire insurance
3. Interest on investment in facilities and inventory
4. Risk
 Storage policies and seasonal price patterns are influenced by price
expectations for the subsequent year.
Methods of Analysis
1. Graph – used to identify uniformities or irregularities in the seasonal
price pattern.
2. Index of seasonal prices
3. Regression techniques – estimates the components of a time series
variable

C. Annual Price Variation

– may use model of price determination under pure competition
in the
 use annual demand and supply functions with annual price
changes arising from their shifts.
Sources
1. Changes in Annual Demand
a. Fluctuations in export demand
b. Variations in prices of substitutes

AECO 122 Lecture Note: Nora DM. Carambas Page 6

 c. Systematic increases in population and income
2. Changes in Annual Production
a. Yields are sensitive to weather conditions and pest and
disease infestations
b. Area planted and harvested change year to year

 Demand for many crops is very inelastic. When substantial year-

to-year shifts in supply are combined with inelastic demand,
price fluctuations are likely to be very great.
D.Trends
 associated with general inflation and deflation in the economy
and with factors specific to agricultural products, including
changes in the tastes and preferences of consumers, increases
in population and income and technological changes in
production.
E. Cyclical Behavior
 pattern that repeats itself regularly with the passage of time.
 The length of a cycle is the time from one peak to the next or
from one trough to the next and is usually related to the time
required to produce a new generation or to wear out and
replace a product.
 A true cycle is self-energizing and not the result of chance
factors.

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 The Cobweb Model
 provides a theoretical explanation of the cyclical component
of certain price-quantity paths through time.
 views prices and quantities to be linked recursively in a causal
chain.
Q1 Q2 Q3 . . . . .

P1 P2 P3
Cobweb Model arises from Three Factors
1. Time lag must exist between decision to produce and the
actual realization of production
2. Producers base production plans on current or recent past
prices.
3. Current prices are mainly a function of current supply which
in turn is mainly determined by current production.
The following chain of events occurs:
a. Current quantity supplied is a function of past prices; i.e.,
Qt(s) = f1(P ) t-1

b. The quantity produced in time t is sold in time t.

Qt(s) = Qt(d)
c. The market clearing price for Qt is determined by the
demand relation.
Pt = f2(Qt(d)).

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 Po S
P2

D
0 Q1
A Cobweb model with a convergent cycle

Assumptions of the Model

1. Price is determined in a competitive market structure; producers are
price takers.
2. Price is mainly determined by shifting levels of very-short-run supply (a
perfectly price inelastic relation within each time period)
3. Production plans are based mainly on current price.
4. An observable lag of at least one time period is required for production
response. (There is a clear lag between price change and production
change)
5. A cycle depends on actual production equaling planned production.
6. For a clear web, demand and supply relations must be static.
 If supply function has steeper slope than demand function, then cycle
converges.
 If demand function has steeper slope than supply function, then cycle
diverges.
 If the slopes of supply and demand functions are equal, constant
amplitude cycle results.
 The cycle will be twice the length of the production lag, where the
model assumes current production is a function of the previous
period’s model.

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Limitations
1. The explicit assumption that production is mechanically dictated by the
last season’s price is weak.
2. Current price levels are influenced also by variables, other than current
production, e.g. government programs.
3. Realized production does not always equal planned production.
 Random non-economic factors can influence the level of demand
and supply.
 Even if all assumptions are met, it is unrealistic to expect a clear
cycle with a constant period.

Two Empirical Facts that are Inconsistent with Cobweb Model

1. Cycles do not converge or diverge; they tend to be continuous through
time.
2. Some cycles are twice the length suggested by the theory.

Four Explanations for the Continuity of Agricultural Price Cycles in the

Context of Cobweb Model
1. The slopes of supply and demand relations are such that the special case of
a continuous cycle results.
2. The assumption that realized production equals intended production is
often unrealistic.
 Before a cycle can converge or diverge, a “random” shift in supply
starts a new cycle, e.g. unusually favorable weather, increase in
demand.
3. Continuous oscillation is permitted by nonlinear S&D functions but stable
system, or nonlinear but non-static S&D functions.
4. Cobweb is inappropriate model for explaining agricultural cycles.

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