Buffering stock means the excess amount of goods that are used to manage the price fluctuation and unpredictable emergencies which occur in the market. What is a common practice to keep a buffer stock of essential commodities and easy necessity is like grains, pulses, etc.?
Depending on the demand and supply cycle, the price of the product vary. However, unless the product crosses a bracket of the estimated change in pricing, extreme precautions and utilization of buffer stock may not be necessary.
Often there are unforeseen circumstances which arise in the market from time to time because of various factors. These circumstances may cause various problems to both suppliers as well as customers in the market. From the supplier’s end, they may have trouble in fulfilling needs in required quantities while keeping the price of the product around average and on the customer’s end, they may face stock out or excessive increase in the price of the product.
As such there can be two scenarios: First in which the availability of the product is less due to which the price increases and second in which there is excessive availability of the product due to which price falls.
In the first case, the buffer stock of the product is released which increase the availability of the product in the market and will help to push down the price so that everyone can afford it, and in the second scenario in which there is excess availability of the product, some of the product can be shifted to stock and preserved as buffer stock which will help to normalize the price of the product.
Thus Buffer Stock acts as a cushion which keeps the drastic price change of the product in control and also keeps the demand-supply cycle balanced.
Methods of Buffer Stock operation in Market
There are primarily two methods by which the buffer stock functions. They are as follows:
#1. Dual pricing method:
In this method, two prices of a product are determined. The first is the minimum price and the second is the maximum price. When there is excess availability of the product, the person or the entity operating scheme, which is usually the government, starts to buy the product which prevents it from falling further.
Similarly, when the availability of the product is poor, and below average, the government starts releasing the buffer stock, which prevents the price from rising above average. This prevents fluctuations in price and maintains balance in the demand-supply cycle.
#2. Single pricing method:
As the name suggests, in the single price method, the minimum and maximum price of the product remains the same. The government, who organizes this scheme, tries to stabilize the price and does not let it fluctuate.
When the demand increases, the scheme operator usually intervenes to stabilize it while in other cases, the price of the product takes care of itself.
Side effects of buffer stock
The primary objective of buffer stock is to create a stable price and balance between demand and supply. It may be incorporated with other different mechanisms to meet the targets which are like promotional of domestic industries.
This can be achieved by setting a price which is minimum but above the equilibrium price. The equilibrium prices defined as the point which is a cross of demand and supply curve and which is a guarantee in itself of giving a minimum price to the producers.
This proves to be an encouragement for the producers to produce more output, and the success surplus can be utilized as a buffer stock by government authorities. Once the price stabilizes, it may be tempting the organizations which are in the market to boost the supply.
One of the advantages of having a buffer stock is that there is always excess food available, which is termed as food security. On the other hand, the downside of having stock is that it may cause destruction of perishable commodities.
This also makes that particular food which is available locally, very expensive for other countries. This can also be costly to the operator. The primary advantage is that when a different form of government intervenes in the market, their mechanism can achieve their objectives directly and quickly.
Example of Buffer Stock
Let’s take an example of perishable products in order to understand the concept of Buffer Stock. Perishable food products like onion are sold daily.
If for some reason, say a natural calamity, the crops of onions are destroyed, then there will be a sudden price rise in the market since the demand of the onion will be more. So the price of onion, which is usually around – say $1 per kilo – would increase to, say $4 a kilo.
In such cases, the price of onion would be very high for an average customer, and people may not buy an onion. During this time, the buffer stock of onion would be released to satisfy some demand of the customers and to bring down the price of onion.
Depending on the buffer stock and demand, the price of onions would be lowered to say around $2.50 a kilo. Although not everyone may buy onions as required, the sale would be higher than it was with $4 a kilo.
Consider a scenario exactly opposite to that of explained above. Consider that there is excess availability of onions in the market than the demand.
In this case, there would be more suppliers than customers, and to sell their stock, they would be lowering the prices than their competitor.
The customer would then prefer the one who is selling for the lowest price, and thus, the average price of the product would fall to say $0.5 per kilo. Before it goes any lower, the government buys the excess surplus and keeps a check on supply.
This again stabilizes the prices of onions and brings to around $0.85 a kilo. This depends on the stock purchased by the government.