When there is a tendency for the price of the good to fall, Buffer stock scheme allows certain amount of the goods supply to be taken out of the market and hence stabilizes a certain price. Coffee, for example, is one of the most traded commodities. By using buffer stock system, it tries to keep the price stable by buying certain amount of supply when there is an oversupply and giving out the good to the market when there is not enough supply.
In the short run, coffee will be relatively inelastic, because the supplier cannot shift to other goods in the short run. (producer substitute).
*ceteris paribus is applied here: Assuming that the demand is constant!
But in the long run, the coffee will be relatively elastic, because the producers then can respond to the changes in demand and allocate the resources to produce other goods which are more highly valued. But when the Buffer Stock scheme is applied, there will be a contraction in quantity demanded because of its high price and the coffee became more elastic. The diagram is shown below.
*ceteris paribus is applied here: Assuming that the demand is constant!
We can see there is a contraction in the quantity demanded. The Buffer Stock Scheme is aimed to stabilize the price of goods so that the producers can make a living. But because of this intervention, there are so many parties affected, which I will discus in point b).
b)
The effect of intervention of the government on the agricultural goods.
As it was listed before, the aim of the Buffer Stock scheme is to stabilize the price of goods to make sure that the producers can still make a living from producing the good. What it does is when the price goes above the ceiling price set, it gives out more stock (the goods are storable) into the market to reduce the price down. On the other hand, when the price goes below the floor price which has been set, the goods will be bought to decrease the amount of goods supplied ( to keep the price up). This of course gives the producer opportunity to produce more and to earn a living. But there’s a serious problem caused by the buffer Stock scheme: misallocating scarce resources.
Misallocation happens as the ‘spill-over’ effect of the Buffer Stock Scheme. It makes the price of commodity goes lower and lower. In the short run, the Buffer stock scheme will work well, but after the long run when it keeps on buying the stock without being able to sell the goods, the company might go bankrupt. The misallocating resource happens here. The resources that could have been used to produce other goods could not be produced. The government then asks the citizens (consumers) to pay higher tax to keep the Buffer Stock Scheme going. The peasants will produce more and more, and there will be oversupply.
Similar thing happens with the subsidy given by the government to the producers. Subsidy is a form of Buffer Stock Scheme which grants from government which acts as an incentive to producers to produce more and lowers the costs of production, which enables the producers to compete with other firms by lowering the price of their goods.
Before the subsidy is given, the model will be like this.
But after the subsidy is given, the model changes to:
The supply curve shifts to the right because subsidy allows the producer to produce cheaper than normal. Thus, this reduces the price down, causing imbalance.
To conclude, the buffer stock scheme aims to help the producers to make a living and encourage them to participate in the market. But the negative spill over effect is that there’s misallocation of scarce resources which goes AGAINST the ideology of economics: Optimally allocating scarce resources because it creates over supply. The impact on the stakeholders will be this. In the short run the producer and the government won’t be aware of the negative spill over effect and continue to intervene the market, but later they will face difficulties in getting rid of the over supply and they might go bankrupt. The bad impact on the consumer will be that they have to pay all the misallocation of resources through higher tax.
