Producers ’ Preference for Price Instability ?

The debate over whether producers prefer price instability to price stability continues, especially where policies are often endorsed that aim at generating stability. Such policies include the holding of agriculture commodity stocks by government to bring about price stability. But why would producers support such a policy given that producers prefer price instability, or do they? Oi argues that producers prefer price instability, which is opposite to the conclusion reached by Massell. In this paper, we take up the issue as to producers’ preference for price instability using the classic welfare economic framework used by Massell and Just et al. We develop a producer price expectation model that brings about price stability, which is possible without storage. We use this as the basis upon which to compare price stability to price instability. Our conclusion is that producers prefer price instability regardless of whether it is due to demand or supply shocks.


Introduction
Schmitz and Kennedy [1] and Kennedy et al. [2] provide evidence that, at least in less developed countries, there is support for the government holding of commodity stocks to bring about price stability.But why would producers support such a policy given that producers prefer price instability, or do they?Oi [3] was the first to demonstrate that producers have a preference for price instability as opposed to price stability.Later, Massell [4] showed cases where the opposite result holds.In this paper, we show why both cases are possible.In comparing the results, Oi does not discuss how price stability could be achieved, but rather he assumes that the stable price in his model is given exogenously.On the other hand, Massell uses government holding of stocks to bring about price stability.
One of the reasons why the findings on the preference for price stability appear A. Schmitz contradictory is that it is unclear how stable prices can be achieved within the price stabilization models.In addition, the source of the price stability plays a major role.Oi considers only cases where price instability is generated by demand shocks, whereas Massell takes into account both demand and supply shocks.
In comparing producer preference for price stability versus price instability, as Schmitz [5] shows, it is not possible to use storage to create price stability, because the amount of storage needed is unavailable.Also, in the Oi case, assuming that price stability is exogenous can be misleading since it is necessary to show how price stability can be achieved endogenously.In both cases of demand and supply shocks, we develop a producer price expectation framework where price stability can be achieved endogenously.This is possible without storage.Our model provides the price stabilization case that is used to compare price stability to price instability.We reach the strong conclusion that regardless of how price instability is generated, producers always prefer price instability to price stability, except in one case where producers are indifferent between the two choices.

Price Instability and Demand Shocks
The basic argument given by Oi [3] can be found in Figure 1 Using the Oi framework, price p 1 and quantity q 1 in period 1 and p 2 and q 2 in period 2 each occur with 0.5 probability.Oi compares these two outcomes with a two-period model where an important assumption is that price p u is given exogenously.Within this context, Oi concludes that producers prefer price instability to stability.This is because the sum of the profits attainable for prices p 1 and p 2 exceed the profits at the stabilized price p u .It follows that total revenue is also greater under instability as In Figure 1(b), we present the argument given by Massell [4] and Just et al.
[6] [7] that supports Oi's contention that producers prefer price instability due to demand shocks.Price instability is given by p 1 and p 2 .The stable price is given by p u .This is brought about through government storage of the amount gh.For a stable price compared to instability, producers lose ( ) In Oi's model, the stable price p u corresponds to output q u .However, in the standard results (Figure 1(b)), where producer price instability is also preferred to stability, the point of comparison is very different.The stable price p u is generated through storage (gh).In the results given by Oi, he compares unstable prices with a stable price where he assumes that this price is given exogenously.The discussion of storage does not enter into his framework.
In the Oi framework, it is not discussed how the stable price p u can be at-  holding of stocks.However, as shown in Schmitz [5], while the result that producers prefer instability holds, prices cannot be stabilized at p u because in Figure 1(a) the storage needed for this result, (be), is unattainable given the unstable prices p 1 and p 2 .This is because the mean quantity produced over the two periods 1 and 2 is q* and not q u .Storage gives rise to prices p* and p** (Figure 1(a)).Thus, while the producers still gain from price instability, the magnitude of the gain can be greatly reduced.The amount is given by Interestingly, however, price stability (p u in Figure 1(a)) can be achieved through storage but under a different producer price expectation model.Consider the case where producers expect the same price and quantity, p u and q u , in both periods 1 and 2 (price p u is the mean of p 1 and p 2 and production no longer occurs at q 1 and q 2 ): 1) Producer price expectations in period 1 = {(p u ) + storage of (q u q 3 )} 2) Producer price expectations in period 2 = {(p u ) -storage of (q u q 4 )} With no storage, prices fluctuate between p 1 and p 2 .To achieve price p u , the amount of storage needed is (q u q 3 ), which is equal to the amount released of (q u q 4 ).We now compare producer preference for price instability verses stability.Producers prefer instability since {(p 1 p u ba) > (p u p 2 cb)}.The net gain to producers from instability is (jba) (but storage is needed to bring about price stability).Thus, even under a feasible stable price scenario, we find that producers prefer price instability to price stability.

Price Instability and Supply Shocks
Oi [3] considered only the case above, where price instability is due to demand shocks.The following discussion focuses on price instability that comes about due to supply shocks.In this case, as Massell [4] and others argue, producers prefer price stability to instability.
In the following, price instability is brought about by supply shocks S 1 and S 2 in Figure 2(a).Demand is given by D. The expected prices and quantities are p 1 (a).Oi confines his argument to price instability that is generated by demand shocks.Consider Figure 1(a) where producer supply is S and price disturbances are caused by fluctuating demands D 0 and D 1 .

Figure 1 .
Figure 1.Storage and Demand Shocks.(a) Demand driven price instability; (b) The standard results.