Buffer Stock: Governments may use buffer stock systems to reduce the market failure
caused by price instability. Evaluate, using an appropriate diagram(s), the effectiveness of
a buffer stock system in reducing market failure.
Buffer stock schemes take place when the government intervenes in the market to try to
reduce price fluctuations. In particular markets, such as commodity markets, prices
fluctuate a lot causing uncertainties, which reduces producers’ confidence in investment as
well as consumers’ confidence in purchasing goods, thus reduces LRAD and may lead to
market failure.
Buffer stock scheme attempt to ensure price stability by government setting a minimum
price to buy supply surpluses and a maximum price to sell demand surpluses, therefore
keeping the market price within a range. As shown by the diagram below, when supply
increases from S to S1, there will be an excess supply of Q3 to Q4 at minimum price, causing
equilibrium price to fall to P1 which is below the minimum price. Government then
intervenes to buy the excess demand, so boosting demand from D to D+G, causing price to
rise to minimum price. On the other hand, when supply decreases from S to S2, there will be
an excess demand of Q1 to Q2, equilibrium price thus rises to P2, which is above maximum
price. Government in this case intervene to sell its buffer stocks, so boosting supply from S2
to S2+G, causing price to fall back to maximum price.
However, the setting of the minimum and maximum price for government to intervene may
not be accurate. Currency itself changes over time, so may the equilibrium price of the
market. If government intervenes using its own setting prices which may be too low or too
high, the prices may be fluctuated even more.
It also depends on the goods that are being stocked up, for goods that are costly to store or
perishable goods, this policy is unsustainable as the government will run out of finance
eventually, and will be left with expensive stockpiles if the price remains low, and the price
of the market not being stabilized.
Intervention of the government also alters the price signal of the market, resulting in price
signal failure. For example, when the government successfully helps to push up the price by
buying all the supply surpluses, this will give a false signal to the producers that they don’t
have to reduce their output, and they will produce the same amount of output next time,
which may again lead to supply surpluses. However, the government may not have enough
finance to support the firm by clearing up the supply surpluses everytime. Therefore, buffer
stock scheme in this case is not sustainable and may lead to market failure due to price
signal failure.
Effectiveness of buffer stock schemes therefore depend on the government’s insight in
terms of the setting of minimum and maximum price, as well as the ability of the individuals
in the market to accurately decide on the amount of output without being distracted by the
government’s intervention.
caused by price instability. Evaluate, using an appropriate diagram(s), the effectiveness of
a buffer stock system in reducing market failure.
Buffer stock schemes take place when the government intervenes in the market to try to
reduce price fluctuations. In particular markets, such as commodity markets, prices
fluctuate a lot causing uncertainties, which reduces producers’ confidence in investment as
well as consumers’ confidence in purchasing goods, thus reduces LRAD and may lead to
market failure.
Buffer stock scheme attempt to ensure price stability by government setting a minimum
price to buy supply surpluses and a maximum price to sell demand surpluses, therefore
keeping the market price within a range. As shown by the diagram below, when supply
increases from S to S1, there will be an excess supply of Q3 to Q4 at minimum price, causing
equilibrium price to fall to P1 which is below the minimum price. Government then
intervenes to buy the excess demand, so boosting demand from D to D+G, causing price to
rise to minimum price. On the other hand, when supply decreases from S to S2, there will be
an excess demand of Q1 to Q2, equilibrium price thus rises to P2, which is above maximum
price. Government in this case intervene to sell its buffer stocks, so boosting supply from S2
to S2+G, causing price to fall back to maximum price.
However, the setting of the minimum and maximum price for government to intervene may
not be accurate. Currency itself changes over time, so may the equilibrium price of the
market. If government intervenes using its own setting prices which may be too low or too
high, the prices may be fluctuated even more.
It also depends on the goods that are being stocked up, for goods that are costly to store or
perishable goods, this policy is unsustainable as the government will run out of finance
eventually, and will be left with expensive stockpiles if the price remains low, and the price
of the market not being stabilized.
Intervention of the government also alters the price signal of the market, resulting in price
signal failure. For example, when the government successfully helps to push up the price by
buying all the supply surpluses, this will give a false signal to the producers that they don’t
have to reduce their output, and they will produce the same amount of output next time,
which may again lead to supply surpluses. However, the government may not have enough
finance to support the firm by clearing up the supply surpluses everytime. Therefore, buffer
stock scheme in this case is not sustainable and may lead to market failure due to price
signal failure.
Effectiveness of buffer stock schemes therefore depend on the government’s insight in
terms of the setting of minimum and maximum price, as well as the ability of the individuals
in the market to accurately decide on the amount of output without being distracted by the
government’s intervention.
