Cointegration and Error Correction Models 1
2 Producer Price-Wholesaler Price
The second relationship is between producer price and wholesaler price. Table 7 shows that there are no sufficient evidences that producer price and
wholesaler price are cointegrated. The Johansen Trace test cannot reject the null hypothesis of no cointegrating vector. It indicates that producer price and rice
miller price are not integrated. Price determination of wholesaler price is not related with producer price, and vice versa. Each price is determined by its
previous prices autoregressive. They behave in the different way both in the short-run and the long-run.
Table 7 Cointegration test for producer price-wholesaler price 3 lags
Johansen Trace Test Level of significant
r0 LR
P-value 90
95 99
16,95 0,1358
17,98 20,16
24,69
1 4,68
0,3317 7,60
9,14 12,53
The factors which may influence this relationship are transaction costs, market information, market power, and market operation policy. Transaction costs
to deliver rice product from producer to wholesaler are high because the rice product has to pass the other marketing intitution, the rice miller. The rice miller
cost potentially increases the transaction costs to deliver rice from producer to wholesaler. As we stated before, transaction costs potentially inhibit the price
transmission. Transaction costs consist of processing cost, storage cost, transportation cost, and marketing margin between producer and wholesaler. The
indirect interaction also influences the transfer of market information. Farmers as producer commonly do not have access about the demand and the price in
wholesaler market. Therefore, there are no price adjustments between producer and wholesaler.
In addition, wholesaler can store the rice product in warehouse and manage its supply. If we compare the price volatilities of them, wholesaler price volatility
18,1 is lower than producer prices volatility 24,9. This ability became market power for wholesaler to control its price and to inhibit the high seasonal
price volatility from producer price. Therefore, they get price which is not really big different either in harvest time or lean time. The Market Operation policy by
Bulog to reduce high price also help wholesaler to have relatively stable price. In this case we use Cipinang Central Market price as wholesaler price. The rice price
in Cipinang Central Market is the reference market price for the stability and availibility of rice stock in Indonesia. So, Bulog always try to mantain the
stability and the availibility of rice stock in Cipinang Market by Market Operation policy. When stocks from wholesale market are secure for retail market, the
retailer price for consumer are also secure to be stable. The Table 8 shows the Error Correction Model result for producer-
wholesaler. We can see there are no significant adjustments each other. This supports the conclusion that producer and wholesaler are not integrated.
Table 8 Error Correction Model for producer price-wholesaler price
Dependent variable ΔWP
t
ΔPP
t
Independent variable parameter
t-value parameter
t-value ECM
t-1
-0,207 -3,346
-0,008 -0,200
ΔWP
t-1
0,200 2,014
0,072 1,128
ΔPP
t-1
0,114 0,670
0,085 0,781
ΔWP
t-2
-0,069 -0,713
-0,024 -0,382
ΔPP
t-2
-0,215 -1,386
-0,376 -3,765
ΔWP
t-3
0,086 0,929
0,001 0,017
ΔPP
t-3
-0,145 -0,860
0,047 0,434
Long-run Equilibrium: WP
t-1
= -868,476 + 1,640 PP
t-1
+ u
t-1
-4,867 -19,865
Note: One , two , and three asterisks indicate rejection Ho: = 0 at 10, 5, and 1 level of significance, respectively. Critical values for 10 = 1,645; 5 = 1,96; and 1 = 2,576
.
3 Producer Price-Retailer Price
The third relationship is between producer price and retailer price. The Table 9 provides sufficient evidences that producer price and the retailer price are
cointegrated. The Johansen Trace test rejects the null hypothesis of no cointegration, but fails to reject the null hypothesis of one cointegrating vector. It
indicates that producer price and retailer price are integrated.
Table 9 Cointegration test for producer price-retailer price 3 lags
Johansen Trace Test Level of significant
r0 LR
P-value 90
95 99
28,76 0,0020
17,98 20,16
24,69
1
7,59 0,1006
7,60 9,14
12,53
But if we see the long-run equilibrium in the Error Correction Model see Tabel 10, the relationship between producer price and retailer price is
implausible. It is not accordance with the theory and unrealistic to be interpreted economically the relationship has negative sign, it should have positive sign.
Therefore we cannot acknowledge that producer price and retailer price are integrated.
Transaction costs are indicated to be one of the factors which influence this relationship. The transaction costs between producer in the upstream and
retailer in the downstream are high. The rice product from producer has to pass rice miller and wholesaler before come to retailer. There are processing cost,
storage cost, transportation cost, and marketing margin which may strongly interfere the price transmission between producer and retailer. There are also no
communication infrastructures to tranfer market information between producer and retailer. So, the imperfect market information mistify the market signal for
price adjustment. Producer price and retailer price are the significant determinant for price
determination in their own market, producer price in the upstream market and retailer price in the downstream market. They behave in different way based on
the conditions and the characteristics in the upstream market and the downstream
market. They are independent each other. Producer price has high price volatility due to the seasonal price, meanwhile retailer price is strongly influenced by price
stabilization policy. Therefore, there is no price transmission between producer price and retailer price.
Table 10 Error Correction Model for producer price-retailer price
Dependent variable ΔRP
t
ΔPP
t
Independent variable parameter
t-value parameter
t-value ECM
t-1
0,005 5,018
0,003 2,453
ΔRP
t-1
0,388 3,884
0,330 3,000
ΔPP
t-1
0,217 2,393
-0,034 -0,341
ΔRP
t-2
-0,374 -3,565
-0,473 -4,094
ΔPP
t-2
-0,022 -0,257
-0,269 -2,853
ΔRP
t-3
-0,144 -1,512
-0,058 -0,556
ΔPP
t-3
0,245 2,715
0,178 1,791
Long-run Equilibrium: RP
t-1
= -4179,049 - 4,564 PP
t-1
+ u
t-1
-0,933 2,011
Note: One , two , and three asterisks indicate rejection Ho: = 0 at 10, 5, and 1 level of significance, respectively. Critical values for 10 = 1,645; 5 = 1,96; and 1 = 2,576.
4 Rice Miller Price-Wholesaler Price
The fourth relationship is between rice miller price and wholesaler price. Table 11 shows there are no sufficient evidences that rice miller price and
wholesaler price are cointegrated.
Table 11 Cointegration test for rice miller price-wholesaler price 3 lags
Johansen Trace Test Level of significant
r0 LR
P-value 90
95 99
17,00 0,1340
17,98 20,16
24,69
1
5,86 0,2093
7,60 9,14
12,53
The Johansen Trace test cannot reject the null hypothesis of no cointegration vector. This indicates that rice miller price and wholesaler price are
not integrated. Each price is determined by its previous own prices autoregressive. Since cointegration result shows there is no cointegration
between rice miller and wholesaler, it is not valid to interpret the Error Correction Model. So we do not need to interpret the Error Correction Model result for this
case.
Table 12 Error Correction Model for rice miller price-wholesaler price
Dependent variable ΔWP
t
ΔMP
t
Independent variable parameter
t-value parameter
t-value ECM
t-1
-0,194 -3,275
-0,018 -0,515
ΔWP
t-1
0,172 1,700
0,046 0,791
ΔMP
t-1
0,212 1,134
0,263 2,432
ΔWP
t-2
-0,073 -0,745
-0,020 -0,355
ΔMP
t-2
-0,236 -1,412
-0,477 -4,930
ΔWP
t-3
0,090 0,933
0,013 0,227
ΔMP
t-3
-0,119 -0,615
0,134 1,200
Long-run Equilibrium: WP
t-1
= -883,319 + 1,610 MP
t-1
+ u
t-1
-4,473 -18,021
Note: One , two , and three asterisks indicate rejection Ho: = 0 at 10, 5, and 1 level of significance, respectively. Critical values for 10 = 1,645; 5 = 1,96; and 1 = 2,576.
Transaction costs to deliver rice product from rice millers in production areas to wholesale market in Jakarta, the Cipinang Market, are high.
Transportation cost is indicated as the biggest contributor for the high transaction costs. In addition, the capability of wholesaler to store the stock in warehouse and
manage time to release supply also influence the rice price determination in wholesale market. Market operation and import policy also help to mantain stable
prices. Therefore the rice price in wholesale market can be controlled and it does not follow rice miller price changes. Rice miller price refers to producer price,
meanwhile wholesaler price refers to retailer price. They are independent each other.
5 Rice Miller Price-Retailer Price
The fifth relationship is between rice miller price and retailer price. Table 13 shows that there are strong evidences that the rice miller price and retailer price
are cointegrated. The Johansen Trace test rejects the null hypothesis of no cointegration, but fails to reject the null hypothesis of one cointegrating vector.
The cointegration indicates that rice miller price and retailer price are integrated.
Table 13 Cointegration test for rice miller price-retailer price 3 lags
Johansen Trace Test Level of significant
r0 LR
P-value 90
95 99
28,29 0,0025
17,98 20,16
24,69
1 6,52
0,1593 7,60
9,14 12,53
On the contrary, the Error Correction Model shows that it has the implausible long-run equilibrium because it is not accordance with the fact. The
long-run equlibrium in the model says that when rice miller price increases IDR 1.000, the retailer price will increase IDR 9.241. The fact is that the retailer price
is not too big different with the rice miller price. So, we cannot acknowledge that rice miller price and retailer price are integrated.
The factors which may influence this relationship are the high transaction costs, imperfect market information, market power, and price stabilization policy.
The rice product needs to pass the other marketing institution, namely wholesaler. There are also processing cost, storage cost, transportation cost, and marketing
margin which contribute to the high transaction costs. In other side, there are no communication infrastructures to tranfer the market information between rice
miller and retailer price. The imperfect market informations mistify the market signal and inhibit the price adjustment between them. The rice miller price
determination is more influenced by producer price. Meanwhile, retailer price is
more influenced by price stabilization policy. Therefore there is no price transmission between rice miller price and retailer price.
Table 14 Error Correction Model for rice miller price-retailer price
Dependent variable ΔRP
t
ΔMP
t
Independent variable parameter
t-value parameter
t-value ECM
t-1
0,003 5,202
0,002 2,656
ΔRP
t-1
0,338 3,356
0,280 2,731
ΔMP
t-1
0,332 3,330
0,126 1,245
ΔRP
t-2
-0,383 -3,657
-0,412 -3,863
ΔMP
t-2
-0,071 -0,775
-0,367 -3,959
ΔRP
t-3
-0,182 -1,905
-0,129 -1,323
ΔMP
t-3
0,378 3,708
0,306 2,951
Long-run Equilibrium: RP
t-1
= -8308,793+ 9,241 MP
t-1
+ u
t-1
-1,215 2,700
Note: One , two , and three asterisks indicate rejection Ho: = 0 at 10, 5, and 1 level of significance, respectively. Critical values for 10 = 1,645; 5 = 1,96; and 1 = 2,576.
6 Wholesaler Price-Retailer Price
The last relationship is between wholesaler price and retailer price. Table 15 shows that there are strong evidences that wholesaler price and retailer price
are cointegrated. The Johansen Trace test rejects the null hypothesis of no cointegration, and fails to reject the null hypothesis of one cointegrating vector.
The cointegration indicates that wholesaler price and retailer price are integrated.
Table 15 Cointegration test for wholesaler price-retailer price 2 lags
Johansen Trace Test Level of significant
r0 LR
P-value 90
95 99
29,64 0,0014
17,98 20,16
24,69
1
11,58 0,0159
7,60 9,14
12,53
Table 16 shows the result of Error Correction Model. In the short-run, the shocks from the retail market are transmitted instantaneously to wholesaler price
significantly. The different sign of the coefficient retailer price changes show there is complex relationship between wholesaler price and retailer price. The
coefficient of error correction term shows it will adjust 0,044 of the divergence to long-run equilibrium each month. The long-run equilibrium is achieved when the
wholesaler price increases about IDR 1.000, the retailer price will increase about IDR 1.391.
Table 16 Error Correction Model for wholesaler price-retailer price
Dependent variable ΔRP
t
ΔWP
t
Independent variable parameter
t-value parameter
t-value ECM
t-1
0,038 4,861
0,044 3,135
ΔRP
t-1
0,411 4,366
0,350 2,051
ΔWP
t-1
0,142 2,760
0,098 1,056
ΔRP
t-2
-0,347 -3,969
-0,505 -3,185
ΔWP
t-2
0,014 0,266
-0,101 -1,062
Long-run Equilibrium: RP
t-1
= 1.391,230+ 1,220 WP
t-1
+ u
t-1
1,848 -6,719
Note: One , two , and three asterisks indicate rejection Ho: = 0 at 10, 5, and 1 level of significance, respectively. Critical values for 10 = 1,645; 5 = 1,96; and 1 = 2,576.
Wholesaler and retailer do direct interaction in the trade. So they have strong linkage in product flow which influence the price determination in both
markets. The transaction costs factor between them are indicated to be relatively low, because commonly wholesalers and retailers take place in one region. There
is no significant trade barrier between them, even the price stabilization policy in the retail market become incentive for wholesaler. The price stabilization policy
creates stable price in retail market along the year. It stimulates wholesaler to keep on adjusting the demand and the price in the retail market continuously along the
year. Retailer also keep on adjusting the price in the wholesaler market, because
the price in wholesaler is the input cost for retailer and the supply from wholesaler to retailer will influence the price determination in the retail market.