In the debate over producer preference for price instability, Oi argues that producers prefer price instability to stability using only the case where demand shocks generate instability. In this case, storage hurts producers. We use the classic welfare economic framework to consider the more likely scenario where instability is generated by supply shocks and, in the absence of storage, producers prefer production and price instability. However, producers can increase their profits by storing part of the production in the low-price period and releasing stocks in the high-price period. The strong conclusion is that producers prefer, on net, price stability to instability when the possibility for storage exists. Under profit maximization, producers, not governments, engage in storage. Producers prefer to produce under unstable prices, but to sell at stable prices. On net, producers prefer price stability.
The debate over both producers’ preference for price instability and the economic effects of commodity storage has a long history (Schmitz et al., 2010). The early writings on these topics are grounded in classical welfare economics, where this approach provides the basis for empirical analyses.1 Oi (1961) was among the first economists to take up the debate over producers’ preference for price instability. However, Oi’s conclusion that producers prefer price instability to stability has created considerable controversy. Also, the effects of commodity storage to bring about price stability are unclear (Schmitz, 2018a). Oi considered only price instability that was created by demand shocks. Here, we extend the Oi result by including the case where price instability is generated by supply disturbances, and show that producers prefer price instability in production but not in consumption. We formulate a two-stage process, in which producers first produce a good and then generate additional gains through storage, which generates demand price stability.
We broaden the discussion to consider the case where price instability is brought about by supply shocks. In the Oi result in
In
From
The conclusion that producers prefer price instability is with reference to our price instability model where the instability is generated by fluctuations in
supply (S1, S2). This is compared to the stable price situation where, over both price periods, producers expect the same price and quantity. That is, the supply curve facing producers in each period is S'.
In
The producer gain from price stability due to storage is { ( i e f c ) + ( i e f c ) } . The gain from production instability is { ( f q u q 1 g ) − ( i e f c ) } . Therefore, the gains to producers from price stability is { ( i e f c ) + ( i e f c ) } + { ( f q u q 1 g ) − ( i e f c ) } . Even if one does not consider the gains from production instability, there is still a positive gain to producers from price stability.
Importantly, there is no need for government to undertake storage to create price stability since it is in the best interest of producers to engage in their own storage activities. However, this is often not possible in less developed countries where producers have inadequate storage. This is often why governments engage in storage activities.
Our conclusion that producers prefer price stability when price instability is due to price shocks is based on our framework where production decisions are independent of storage activities. Producers prefer price instability in production, but prefer price stability in consumption. In this context, storage is feasible, which was not the case in the earlier literature where producers consider production and storage as a joint activity in the production decision-making process (Massell, 1970).
There are several limitations to our analysis. First, uncertainty is not considered, and should be taken into account in future work. For example, a model could be developed, where using our above framework producers have a planning supply curve S' in
The author thanks G. Cornelius van Kooten, P. Lynn Kennedy, and Carol Fountain for comments.
The authors declare no conflicts of interest regarding the publication of this paper.
Schmitz, A., & Chegini, C. (2020). Producer’s Preference for Price Instability: Revisited. Theoretical Economics Letters, 10, 1193-1197. https://doi.org/10.4236/tel.2020.105070