Buffer stocks

A buffer stock scheme is a method of intervening in a market in order to stabilise price within an agreed range. There is evidence that buffer stocks were used in ancient Egypt during the Middle Kingdom1, some 3000 years ago2, and in ancient China3 as part of a national food reserve system. The aim of such schemes was to ensure that sufficient grains were put into storage at times of surplus production, and then brought out of storage when harvests were poor.

Controlling instability

Unlike manufactured goods, food production is subject to factors which are largely beyond human control, including variable weather, natural disasters, and the impact of pests and diseases. While modern production techniques and scientific land management have greatly reduced the impact of such shocks, food production is still prone to changes in weather and natural factors. Buffer stocks are one example of how instability can be managed and controlled.

Example

Assume that buffer stock managers set a target range of prices between A and B in the diagram below, with current equilibrium at e, where demand equals supply (D=S). If supply increases (to S1) as a result of an unusually good harvest, the price would drop below price Pb to P1 - out of the accepted price range. The buffer then ‘clicks in’ so that stocks are bought, shifting demand to D1, and then stored. The effect is that price is driven up to Pb, into the target range, at equilibrium e2. Of course, the buffer stock managers could purchase more, to push the price nearer to centre of the target range.

Buffer stock diagram

With a bad harvest supply shifts to S2, causing price to rise out of the target range, at P2 and equilibrium e3. Stocks are then released, which shifts the supply curve to S3, pushing the price down to Pa, with a new equilibrium at e4. Again, the buffer stock managers could release a greater supply, to push price nearer to the centre of the price range.

There are other price stabilisation schemes, including guaranteed prices.



Video on buffer stocks

Unstable markets

Agricultural and other primary markets face several significant problems, which may require government intervention in the market. Instability results from the particular supply characteristics existing in these markets, including:

  1. Supply in the long run is relatively elastic – land can often be switched between crops depending on price fluctuations.
  2. However, supply in the short run is perfectly inelastic, given that it is difficult if not impossible to alter production during a growing or rearing season.
  3. Elasticity of supply
  4. In addition, these markets are susceptible to the impact of unpredictable shocks, including bad weather and disease.
  5. Finally, the assumption (at least in the past) was that small-scale famers and growers suffered from information failure as they fail to react rationally to market changes.

If we then assume that demand is relatively slow to adapt to such changes, we can see that the market can become unstable over time. Just a small supply shock can trigger an increasingly volatile reaction.

We can assume that the market starts at equilibrium at P and Q.

Buffer stock

A small shock will reduce short run supply to S1. The effect of this is to push up price to P1. At P1, farmers plan to increase output to S2, but the effect of this increased output is to push down price in the following year, to P2.

Buffer stock

At this lower price, farmers plan to cut back on production to S3. The impact of this is that prices move up and down to create instability. The interaction of demand, short-run and long-run supply forms the basis of the so-called cobweb theorem, first discussed by American Economist, Mordecai Ezekiel, in the 1930.

Buffer stock

This instability can cause the following problems:

  1. Unstable income for farmers and growers.
  2. Consumers find it difficult to plan their budgets.
  3. Producers refrain from allocating income to investment in new technology.
  4. Agricultural workers enter and leave the labour market as prices rise and fall.
  5. Wages are often kept low as farmers and growers look to keep costs low.
  6. National food supplies can fall, resulting in problems with ‘food security’.

Buffer stocks provide one solution to the problem.

Criticisms of buffer stocks

Buffer stocks can be criticised in a number of ways, including:

  1. Buffer stocks can distort the effective working of markets, sending out 'faulty' price signals to producers, encouraging them to over-produce. For example, when stocks are purchased price is driven up, which signals to producers to produce more, which may lead producers to allocate more resource to production, and contribute to increases surpluses in the future.
  2. Buffer stocks work best when the commodity can be stored - if commodities are perishable, such most fruits, buffer stocks are not possible.
  3. This can be criticised because it leads to the inefficient allocation of scarce resources.
  4. In addition, building an operating buffer stocks creates additional costs, including the costs of storage, management and stock administration.
  5. For a buffer stock system to work it will require some surplus production at the outset - if the scheme starts with a series of poor harvests the stock will be empty and nothing is available to be released.
  6. Information failure may also mean that the system cannot operate with precision - one reason why a price 'range' is set which accounts for this imprecision.
  7. As with other government intervention schemes, buffer stocks can lead to moral hazard - with intervention seen as an insurance policy against losses incurred by inefficient production decisions.
  8. Finally, there may also be more effective alternatives to price and market stabilisation.
Guaranteed prices

How do guaranteed prices create price stability?

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Fiscal policy

How can fiscal policy influence aggregate demand?

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Monetary policy

Is monetary policy more effective at controlling inflation?

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Endnotes and sources

1. Middle Kingdom is a period of ancient Egypt covering the period from approximately 2030 to 1650 B.C. (Dynasty 11 to Dynasty 13)

2. Ezzame, M, 2002, Accounting and redistribution: The palace and mortuary cult in the Middle Kingdom, ancient Egypt, Accounting Historians Journal, Volume 29, June 2002, viewed 21 February 2021 <https://core.ac.uk/download/pdf/288025206.pdf>

3. Zhang, Y,Fan, G, Whalley, J, Economic Cycles in Ancient China, Working Paper 21672, NATIONAL BUREAU OF ECONOMIC RESEARCH, 1050 Massachusetts Avenue, Cambridge, MA 02138, October 2015, viewed 20 February, 2021 <https://www.nber.org/system/files/working_papers/w21672/w21672.pdf>


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