Commodity Prices and Transaction Coordination through Contracts

My dissertation research is composed of three essays to investigate the role of procurement contracting, market structural features, and market participants¡¦ behavior as determinants of the implications of contracting for spot price determination, market segments, and welfare effects. A key feature of procurement contracting is the partitioning of the market into a contract segment and a residual, open (spot) market segment. This research presents three alternative considerations of the role of procurement contracting in price determination.For the first essay, a two-sector general equilibrium model is introduced by analyzing the optimizing behavior of agents, who produce and purchase commodities in the presence of forward contracting, and derived a set of individual supply and demand functions under price uncertainty and risk aversion. By setting up a formal optimizing model, we are able to understand how activities of production and consumption should be modifies as a consequence of introducing forward contract markets. Assuming clearing markets, equilibrium spot price distributions are solved in the rational expectations framework. We examine the effects of contracts on spot market price behavior. Specifically, both price level and price volatility effects are considered. Simulation results show that as hedge increases mean of spot price falls, and variance increases. These results are intuitive though also dependent on parameterization.The second and the third essays of this research use intuitive concepts from game theory that are currently useful to formalize and investigate various forms of market structure. For the second essay, the contract market itself is assumed subject to adverse selection and moral hazard in that quality is unknown. We look at how agents effectively signal their quality using a modified framework a la Spence (1973). The results show that the high quality seller receives quality premium on forward contracts, whereas the low quality seller receives lower forward contract price than the expected spot price due to quality discount. Also, under the optimal incentive contracts provided by the buyer the high and the low quality sellers supply their total production to the forward contract market. In other words, the spot market does not exist if all feeders in market are offered optimal contracts.For the third essay, we set up a bargaining model between buyers and sellers for their contracts in which they bargain over price and/or quantity. The bargaining protocol is a fairly standard Rubinstein bargaining model of alternating offers (see Rubinstein (1982)). The results in this essay show that bargaining is not just increasing prices paid to farmers comparing with the situations in monoposy and in competitive market; the total surplus associated with bargaining are positive. We conclude that the existence of market-wide pooling of revenues mitigates the problem of the processor¡¦s market power that individual producers face. In absence of the introduction of a cooperative, we find it likely that individual producers receive the lowest price and zero profit.