Spatial Market Efficiency and Equilibrium

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2.5 Spatial Market Efficiency and Equilibrium

An efficiency of a market refers to the condition of how all relevant information are fully reflected by a market, particularly in determining prices of commodities marketed in the concerned market [Fackler and Goodwin 2001, Lence and Falk 2005]. In the analysis of market integration, the information includes demand, supply, and transaction costs. The definition of efficiency also underscores whether the price at a particular period t can be the best forecast value for the price at the next period t+i , i=1,2,3,...n, since it is assumed to have all available information of the market Barret, 1996. According to the spatial market integration term, the efficiency is determined by the response of arbitrageurs to demand and supply shock in the market. Arbitrageurs will transport the commodity from the lower price market to the higher one, until the inter-market price differences is equal to the transaction costs and thus make profit from that. These processes ensure equality of transfer costs and inter-market price differences which imply a long run relationships or co-integration between the markets involved . In competitive markets, ensured by the arbitrageurs‟ actions, the inter- market price difference should not be higher than the transfer cost of trading the good between markets. If this condition is not fulfilled, i.e. the transfer costs for a commodity between markets are higher than the inter-market price difference, and then the efficiency of the markets is not achieved. However, it is important to consider that market efficiency, which is necessary for market equilibrium, is different from market integration, the mainly emphasizes on the flow of commodity and price information, without requiring the condition in which arbitrage opportunities are fully exhausted. This implies that the presence of trade is not required for the accomplishment of market integration as well as market efficiency. Furthermore, the minimization of inter-market transfer costs and quasi rents from binding quota is necessary for market efficiency in spatial distinct markets Barrett, 2001. If transaction costs of trade are excessively high, due to trade barriers, poor transport infrastructure, and so forth, markets can be uncompetitive spatial equilibrium and yet not be socially efficient. Therefore, it implies that the presence of market integration does not guarantee the 18 maximization of welfare unless the trade costs and the quasi-rents due to binding trade quotas are minimized Barret, 2005. The spatial equilibrium condition SEC will occur when P A = P B + T BA , where P A is importing price from B to A, P B is exporting price to A, and T BA is transaction trade cost from B to A. Except this equilibrium conditions, there two possible situations, i.e. 1 If P A P B + T BA , there will be more trade from B to A until restoring the SEC. This is when arbitrage occurs. 2 If P A P B + T BA, there will be no trade until P A gets too small or P B so big, that P B P A + T BA , than trade will occur from A to B. It is necessary to notice that T BA ≠ T AB due to geography aspect namely “backhauls” phenomenon.

2.6 Deforestation: Supply and Demand Theory for Forest Product