What is the price discovery process for agricultural products?


Vegetable market

Commodity markets have been recognized as effective price discovery systems on a global scale. If the regulations are more flexible and more participants are aware of how they work in India, then commodities can play a very important role. Constant efforts are made by the regulator and the exchanges on these aspects, but to make the agricultural commodity markets more affective and participatory, the uncertainty linked to the delisting or the prohibition of certain contracts must be lifted as soon as possible.

Fundamental analysis is involved in the process of price discovery. It is primarily the study of the factors that affect the supply and demand of a particular asset class such as commodities. To understand the behavior of commodity prices, it is important to gather and interpret information about the demand for and supply of commodities. In order to have a better understanding of the dynamics of supply and demand, it is necessary to be familiar with the laws of supply and demand and how these factors influence the final price. Market prices for commodities are determined based on demand and supply dynamics. For example, if demand is greater than supply, the price of an asset will increase because buyers are willing to pay more due to its scarcity, which favors sellers. Likewise, if supply exceeds demand, buyers will not be willing to pay as much as they might if the supply were lower. This is because an asset with high supply but low demand is readily available for purchase. As a result, the price often favors buyers.

The prices of commodities fluctuate so often that it becomes difficult to determine the exact price at any given time. Indeed, the factors affecting demand and supply are diverse and independent having a different origin. Therefore, price discovery is an ongoing process. It becomes all the more important for participants in the trade to know where the price is likely to be heading at any given time, as the price of the commodities for which future trades are made is volatile and changes in real time.

Understand the concept of equilibrium price of buyers and sellers

Price (P *) represents the equilibrium point where buyers (i.e. demand) and sellers (i.e. supply) meet in the market (Figure below). New market information (e.g. a poor harvest in a foreign market, a generalized animal disease outbreak, a major revision of a previous estimate of agricultural production, etc.) may change the expectations of market participants and lead to a new equilibrium price when sellers revise their bid prices and buyers revise their bids based on the new information.

An outward shift in demand relative to the market equilibrium (due, for example, to news of a bad foreign harvest raising expectations of an increase in U.S. exports) would raise the price P * as demand shifts to the right along the supply curve. Likewise, an outward shift in supply relative to market equilibrium (due, for example, to an upward revision of the estimate of planted area by USDA / Government of India / NOPA / SOPA increasing expectations of higher production) would lead to a lower price P * as supply shifts to the right along the demand curve. These two hypothetical price changes would only be short term.

In the long term, growers would modify their planting decisions in light of new price expectations. All of this shows that the market has strong growth potential. In a liberalized regime, we should welcome it and treat the derivatives market as an integral part of the economy. Derivatives provide hedging opportunities and also help in price discovery. Adverse market effects, if any, result from improper regulation and the market as such cannot be blamed for this. The market outlook therefore depends on the efficiency of the regulator.

The speed and efficiency with which various price adjustments occur depends, in large part, on the structure of the market in which a product is traded. The common attributes of the market structure are:

Number of buyers and sellers – a greater number of market players is generally associated with increased price competitiveness.

The homogeneity of the product in terms of type, variety and quality, and end-use characteristics— greater product differentiation is generally associated with greater price differences between products and markets.

Number of close replacements – Closer substitutes mean buyers have more choice and are more price sensitive.

Storage of goods – greater storage capacity gives the seller more options in terms of when and under what conditions to sell his products.

Transparency of price formation, for example, open auctions versus private contracts – greater transparency prevents price manipulation.

Ease of transfer of goods between buyers and sellers and between markets – greater mobility limits price differences from one region to another.

Artificial restrictions on market processes, for example, government policies or market collusion of a major participant – more artificial restrictions tend to prevent the price from reaching its natural equilibrium level. Some restrictions (e.g. import barriers) limit supply and keep prices high, while other types of restrictions (e.g. collusion in the market by a few large buyers) can suppress the prices of the product. Marlet.


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