Transcript Spatially Separated Markets

Spatially Separated Markets
AG BM 102
Introduction
• Interregional competition is an important
part of agriculture
• How can they afford to ship those potatoes
all the way from Idaho? Can’t we compete
with our potatoes?
• If energy prices rise, will our peach
industry be more competitive?
• Why isn’t Pennsylvania more self-sufficient
in food production?
Basic situation
• Two regions – west & east
• Each has a supply, each has a demand
• With no trade, each would be selfsufficient in this crop – potatoes
• With trade, part of the eastern market is
served by western potatoes.
Some Intuition
• Potato price in west without trade is
$5/cwt.
• Potato price in east without trade is
$11/cwt.
• Costs $2 per cwt to ship potatoes across
country – either way.
• Could you buy potatoes in east and sell
them in west?
Intuition (cont.)
• How much would you make?
• Could you buy potatoes in west and sell
them in the east?
• How much would you make?
• If you did, what would happen to the price
in the east?
• What would happen to the price in the
west?
Intuition (cont.)
• At what point would you quit shipping
potatoes?
• Why?
• America now has one big potato market
• P east = P west + freight
• Total Quantity Demanded = Total Quantity
Supplied
Some Math
No Trade
S1  D1
S 2  D2
An Example
Market 1
No Trade
D1  34  2 P1
S1   2  P1
S1  D1
 2  P1  34  2 P1
36  3P1
P1  12, S1  D1  10
Market 2
No Trade
D2  11  P2
S 2  1  P2
S 2  D2
11  P2  1  P2
P2  5, D2  S 2  6
Things to Notice
• Market 1 has a higher price than market 2
• The price difference is greater than the
transport price, which is $2
• So, someone could buy in market 2 at $5,
ship to market 1 at a cost of $2, and sell it
for $12 and make money
Math
With Trade, if P1<P2
S1  S 2  D1  D2
P1  PT  P2
If P1>P2 then
P2  PT  P1
Math with trade
S1  S 2  D1  D2
 2  P1  1  P2  34  2 P1  11  P2
3P1  2 P2  46
PT  2
P2 + 2 = P1
With Trade (cont.)
3( P2  2)  2 P2  46
5P2  40
P2  8, P1  10
S1  8, D1  14, S 2  9, D2  3
QT  D1  S1  S 2  D2  6
Excess Function Market 1
D1  34  2 P1
S1   2  P1
ED1  D1  S1
ED1  34  2 P1  (  2  P1)
ED1  36  3P1
Excess Function – Market 2
D2  11  P2
S 2  1  P2
ES 2  S 2  D2
ES 2  1  P2  (11  P2)
ES 2   10  2 P2
Steps for solving
• Solve without trade
• Find high-priced market (h) and low priced
market (l)
• Ph = Pl + Pt
• Sh + Sl = Dh + Dl
• Substitute in values and solve for Prices
and quantities
How to do graphs
• You need three graphs: market 1, market
2, and trade
• Put the supply and demand curves on
market 1 & 2 graphs
• Put excess demand on the graph for the
high priced market
• Put excess supply on the graph for the low
priced market
• Put excess demand and excess supply on
the trade graph
• Add the transportation cost to the excess
supply curve
• Where this line crossed excess demand
determines the price in the high priced
market with trade and the quantity traded
• At that quantity, the price in the low priced
market is where it crosses excess supply
• Plot the with trade prices on each market’s
graph and identify quantity supplied,
quantity demanded and quantity traded
Remember the excess demand
is always the high priced market
and excess supply the low
prices market
Concluding Comments
• Concept is easy – Price differences
encourage trade
• Trade pushes prices closer together- until
price difference equals transport costs
• Math and graphs are more complicated
• Our whole economy depends on this
• Every meal we eat reflects it