Assess the possible advantages and disadvantages of using a buffer stock scheme to control the price of an industrial raw material. It is often argued that buffer stock schemes should be used to...
Assess the possible advantages and disadvantages of using a buffer stock scheme to control the price of an industrial raw material. It is often argued that buffer stock schemes should be used to control the prices of industrial raw materials such as nickel and tin.
An advantage of a buffer stock scheme is that it can moderate large price fluctuations in a given commodity market, providing greater assurance of long-run supply at a cost at which production will remain profitable. In the case of a food stock like grain, buffer stocks can moderate price-gouging by oligopolists in case of a bad harvest. Ancient Egyptian state granaries as well as the Chinese imperial granaries, for example, would load up on grain when prices were low, and then sell into the market when grain was scarce to keep prices down. Food price stability led to greater political stability.
In a manufacturing industry characterized by increasing returns to scale, securing a stable supply of essential commodity inputs through a buffer stock scheme can give a firm a price advantage to achieve additional market share and potentially knock out competitive rivals when high commodity prices are negatively impacting them.
A potential downside to these market interventions is that they distort prices and thereby disrupt the essential price-signaling function of markets that tells producers what to produce and in what quantities. This can lead to the misallocation of capital and potentially drive producers to leave or enter a market based on the distorted price, reducing market efficiency.
The major advantage to having a buffer stock of important raw materials is that it will protect industries from fluctuations in the prices of the materials. When prices are left to be determined by supply and demand, they can fluctuate significantly. Such fluctuations can be bad for firms because they make it very difficult for firms to plan. Therefore, keeping the buffer stock makes it easier for firms to know what their costs will be and to plan accordingly. This helps the firms and, thereby, helps the larger economy.
On the other hand, maintaining such buffer stocks imposes costs on the taxpayers. The government has to pay to obtain and store the stocks. This is not free. In addition, by doing this, the government is in essence subsidizing some industries. It is using government money to support the industries that use that particular raw material. Economic theory suggests that subsidies can result in a misallocation of resources. Subsidies artificially raise the supply of the thing that is being subsidized. This is, in economic terms, inefficient.