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Home Field Trips Rural Life and Agriculture Tour Commodity Agreements

Theories

Commodity Agreements

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Producing commodities such as coffee, cotton or tobacco for the international markets is a hazardous business. All are grown commercially in Zambia. Commodity markets are characterised by instability and uncertainty. This uncertainty may arise due to

• fluctuations in the market prices due to market conditions changing
• changes in prices due to changes in exchange rates
• changes in foreign government protectionist measures

Often producers (and sometimes consumers) of commodities will co-operate together in an attempt to introduce more stability into the markets. These agreements attempt to stabilise prices. Indeed with most primary commodities they are used to prevent prices from falling below certain levels.

• A production quota system such as the International Coffee Agreement operated by the International Coffee organisation between 1962 to 1989
• A buffer stock system

Production quota system
A production quota system is an agreement by producers to limit the amount supplied to the market place. By forming a cartel and co-operating together, the producers attempt to influence the market supply and hence the price. The individual members of the cartel are then given a quota on the amount they are able to produce. If the intention is to prevent the price falling the cartel members will be instructed to reduce their quotas.

If the market price for the commodity was P1 and the cartel wanted to raise the market price to a target price of P2 then by reducing the quotas produced by each one of the members of the cartel the market supply curve can be shifted to the left and the market price raised.

Buffer stock system
This system is operated by a group of producers, known as the buffer stock authority, often with government support setting a target price or a target price band i.e. a price ceiling and price floor. If the market conditions are such that a surplus is produced, which would cause the price to fall below the target price, the buffer stock authority will agree to purchase the surplus at the intervention price. If market conditions have produced a shortage then the buffer stock authority will prevent the price from rising above the target price by selling off previously acquired stocks (assuming they exist).

In the diagram above shifts in the supply curve between S2, S3 and S4 will only result in the price changing between the acceptable price band. If a supply shock causes the supply curve to shift to the right to S5 then the buffer stock authority will intervene and purchase the surplus Q4-Q5 thus preventing the market clearing by itself through a lowering of the equilibrium market price to P1. If the supply curve shifted to the left then the buffer stock authority would release stocks equal to Q1-Q2 on to the market thus preventing the price rising to P4.

In the case where the surplus is bought there are number of options that can happen to the stock

1. It can be stored
2. It can be destroyed
3. It can be sold to other countries
4. It can be given as overseas assistance.

Each option has a number of costs associated with each. Storage is expensive and involves an opportunity costs of the storage facilities. Destroying surpluses especially if the surplus is a food is morally questionable in a world devastated by poverty and hunger. Selling to other countries at low prices or dumping can undermine domestic producers in the countries where the goods are sold. Giving the food as aid could, it is argued, lead to a dependency culture.

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