I was wondering, do future's markets cause goods to be sold for a high price? I mean, the point of such markets is to store up goods for times of dearth so I would think that prices would be lower...but then time-preferences wouldn't be fulfilled.
fakename: I was wondering, do future's markets cause goods to be sold for a high price? I mean, the point of such markets is to store up goods for times of dearth so I would think that prices would be lower...but then time-preferences wouldn't be fulfilled.
Futures contracts allocate commodities between the present and the future. More of the good sold in the present (on the "spot market") means less of the good available in the future (on the "futures market"), and vice versa. Therefore, the present and the future compete how much of the same commodity it gets.
In a time of plenty, some of the commodity will be sold immediately on the market for consumption, while the remaining may be stored for future use. In the event a future crises is suddenly announced, where more needs to be reserved for the future, the future price will immediately jump in value.
How much the spot price will jump depends on how much of the present commodity is given up in favor of future use. If more of the commodity becomes stored up, instead of immediately sold for consumption, then the spot price will increase and the future price will decrease, until an equilibrium is reached.
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Time preference determines present and future allocations through arbitrage conditions. High time preference favors more of the commodity available in the present than in the future. Low time preference favors more of the commodity available in the future than in the present.
The prevailing interest rate determines the arbitrage condition for the commodity. For example. let's say a barrel of oil on the spot market is selling for $100, while the future price for delivery of a barrel for delivery one year from now is $105.
If the interest rate is at 5% annually, then no arbitrage is available to take advantage of the unequal prices.
However, if the interest rate decreases to 1% (because of a lower time preference), then someone can borrow $100 at 1% interest rate, buy the barrel of oil for $100, then sell the same barrel for $105 one year from now, and pay off the loan at $101, for a $4.00 future profit.
This profit condition will exist until more traders enter the deal and eliminate the arbitrage. Traders would do this by buying up more oil in the present, causing a rise in the spot price, while selling more oil in the future, causing a drop in the future price. More oil is available in the future, and less oil is available in the present.
However, if the interest rate increases to 10% (because of higher time preference), then someone, who owns a barrel of oil, can sell the barrel at $100, put the money in a bank account earning 10% interest, withdraw the funds at $110, then buy back a barrel at $105, for a $5.00 future profit.
Traders would eventual eliminate the arbitrage condition by selling more oil in the present, causing a drop in the spot price, while buying more oil in the future, causing a rise in the future price. Less oil is available in the future, and more oil is available in the present.
Think Blue: fakename: I was wondering, do future's markets cause goods to be sold for a high price? I mean, the point of such markets is to store up goods for times of dearth so I would think that prices would be lower...but then time-preferences wouldn't be fulfilled. Futures contracts allocate commodities between the present and the future. More of the good sold in the present (on the "spot market") means less of the good available in the future (on the "futures market"), and vice versa. Therefore, the present and the future compete how much of the same commodity it gets. In a time of plenty, some of the commodity will be sold immediately on the market for consumption, while the remaining may be stored for future use. In the event a future crises is suddenly announced, where more needs to be reserved for the future, the future price will immediately jump in value. How much the spot price will jump depends on how much of the present commodity is given up in favor of future use. If more of the commodity becomes stored up, instead of immediately sold for consumption, then the spot price will increase and the future price will decrease, until a equilibrium is reached. . . . Time preference determines present and future allocations through arbitrage conditions. High time preference favors more of the commodity available in the present than in the future. Low time preference favors more of the commodity available in the future than in the present. The prevailing interest rate determines the arbitrage condition for the commodity. For example. let's say a barrel of oil on the spot market is selling for $100, while the future price for delivery of a barrel for delivery one year from now is $105. If the interest rate is at 5%, then are no arbitrage available to take advantage of the unequal prices. . . . However, if the interest rate decrease to 1% (because of a lower time preference), then someone can borrow $100 at 1% interest rate, buy the barrel of oil for $100, then sell the same barrel for $105 one year from now, and pay off the loan at $101, for a $4.00 future profit. This profit condition will exist more traders enter the deal and eliminate the arbitrage. Traders would do this by buying up more oil in the present, causing a rise in the spot price, while selling more oil in the future, causing a drop in the future price. More oil is available in the future, and less oil is available in the present. . . . However, if the interest rate increases to 10% (because of higher time preference), then someone, who own a barrel of oil, can sell the barrel at $100, put the money in a bank account earning 10% interest, withdraw the funds at $110, then buy back a barrel at $105, for a $5.00 future profit. Traders would eventual eliminate the arbitrage condition by selling more oil in the present, causing a drop in the spot price, while buying more oil in the future, causing a rise in the future price. Less oil is available in the future, and more oil is available in the present.
How much the spot price will jump depends on how much of the present commodity is given up in favor of future use. If more of the commodity becomes stored up, instead of immediately sold for consumption, then the spot price will increase and the future price will decrease, until a equilibrium is reached.
If the interest rate is at 5%, then are no arbitrage available to take advantage of the unequal prices.
However, if the interest rate decrease to 1% (because of a lower time preference), then someone can borrow $100 at 1% interest rate, buy the barrel of oil for $100, then sell the same barrel for $105 one year from now, and pay off the loan at $101, for a $4.00 future profit.
This profit condition will exist more traders enter the deal and eliminate the arbitrage. Traders would do this by buying up more oil in the present, causing a rise in the spot price, while selling more oil in the future, causing a drop in the future price. More oil is available in the future, and less oil is available in the present.
However, if the interest rate increases to 10% (because of higher time preference), then someone, who own a barrel of oil, can sell the barrel at $100, put the money in a bank account earning 10% interest, withdraw the funds at $110, then buy back a barrel at $105, for a $5.00 future profit.
Thanks, that really clears it up.