Buffer Stock Scheme

Buffer Stock Scheme

A buffer stock scheme is a system through which the government buys a product when there is an excess supply and sells when there is less supply for the purpose of maintaining a fixed or target price. It is a method of government intervention in the market aimed at preventing fluctuations in the prices of products such as natural resources and agricultural products, e.g. crude oil, wheat, etc. These products are susceptible to price volatility owing to supply or demand constraints. For example, unfavourable weather conditions may result in poor harvest and lower supply while favourable weather conditions produce a good harvest and increase supply.  The demand for these products is inelastic and a lower price leads to a small percentage rise in quantity, thereby reducing consumer expenditure and producer revenue.

In addition, the price increases when there is a decrease in supply and decreases following an increase in supply. Consequently, incomes made by the producers may be unstable due to price fluctuations. If there is a plentiful wheat harvest, for example, supply will shift from S1 to S2, thereby reducing the price from P1, the fixed price to P2, the new equilibrium price. But the government will buy up the excess supply Q1Q3 to ensure the price is back at the fixed or target price P(see Figure 1 below).


Figure 1: Buffer stock when there is an increase in the supply of wheat

Diagram showing buffer stock when excess supply is bought

If the harvest is poor, supply will reduce from S1 to S2 and the new market price P2 will exceed the price fixed by the government (see Figure 2 below). However, the government will sell Q1Q3 to take supply back to S1 at the set price of P1.


Figure 2: Buffer stock when there is a decrease in the supply of wheat

Diagram showing buffer stock when supply decreases

The buffer stock scheme is similar to both minimum pricing and maximum pricing. In Figure 1 above, the fixed price P1 is above the new equilibrium P2 like the minimum price. The fixed price is below the new equilibrium like the maximum price in Figure 2 above.


Buffer stock scheme with a target price range

The government may establish a target price range instead of setting one target price. That is to say, there will be a maximum price target and a minimum price target. The equilibrium or market price is allowed to fluctuate within the range. The government intervenes only when the equilibrium price is outside the range, i.e. above the maximum price target or below the minimum price target. The government buys or sells buffer stocks based on fixed minimum or maximum prices. In Figure 3 below, the market price P1 is within the target range (maximum and minimum prices). An increase in supply from S1 to S2 will drive down the price to P2 below the minimum price. The government will buy the excess supply which will increase demand from D1 to D2; the price will rise from P2 to P3 which is within the target range. 


Figure 3: Buffer stock when there is an excess supply

Diagram showing buffer stock when there is excess supply

 An increase in demand from D1 to D2 results in a rise in price from P1 to P2. But P2 is above the maximum price target set by the government. The government sells from its buffer stock which shifts the supply from S1 to S2, thereby reducing the price to P3 which is within the established range.


Figure 4: Buffer stock when there is shortage

Diagram showing buffer stock when there is shortage
Benefits of a buffer stock scheme

Assured source of income for the producers
When there is excess supply the government buys the excess from the producers and stores it. Therefore, the producer is protected from tieing up his capital in unsold stock. In addition, the price is not allowed to fall below the target price as a result of the rise in supply. And because many of the goods have inelastic demand, a fall in price will lead to a smaller percentage rise in quantity demanded and reduce total revenue. 

Government gains from the system
The government makes a profit from the scheme because it buys when the prices are low and sells them when prices are high. The prices are low when there is excess supply; they are high when there is a shortage of products. The profit made can be used for developmental projects. 

Encourages investment
The protection against fluctuating earnings provided by the scheme prevents producers, such as farmers, from going out of business. It also encourages more investment from both existing and new investors. The economy benefits through employment creation and increased Gross Domestic Product (GDP). 

Consumers do not pay exorbitant prices
When supply decreases, the price rises. But consumers do not pay the high price because government releases stocks into the market, thereby driving down the price to the target level or range. The standard of living improves because they have access to more goods, especially basic food items.

Prevention of hunger and poverty
A buffer stock scheme for agricultural products and other primary products prevents the shortage of food and other essential products. This prevents scarcity, hunger and inability to access essential products.


Demerits of the buffer stock scheme

It requires a lot of money
The government or any other institution setting up the scheme needs money to buy stock for storage when there is excess supply in the market. This is to prevent the price from falling below the set or target price. Also, the cost of storage and administration of the scheme contributes to increasing the capital requirement of the system.

The use of money for a buffer stock system will reduce the amount available for the provision of amenities, e.g. hospitals, education and roads.

Overproduction may make the scheme unsustainable
Producers tend to overproduce because there is a guarantee that government will pay for the excess. Overproduction increases the amount of the excess government has to buy. This leads to an increased financial burden on the government which may lead to the failure or non-sustainability of the system. 

Producers become inefficient
Over-reliance on government support may not encourage producers to cut costs in order to be price competitive in the domestic and international markets. If the government does not ban or impose barriers on imports, demand for their products will fall and revenue will eventually decline.  They may also not innovate in order to increase the quality of their products.

Inadequate information
The government does not have adequate information to determine the appropriate level of intervention, the target price for the products, and the timing of intervention. Intervention, as a result, may fail to achieve the desired effect. For example, estimating the amount of surplus, and the quantity to buy or sell may be incorrect as they change from time to time. It is also difficult to determine the maximum and minimum price targets that are fair. It is possible they have become outdated by the time the government gets the data.

Perishability
Most of the products are perishable in nature since they have a specific shelf life. Also, they require different storage requirements and have to be monitored to see whether they have spoilt or been destroyed by pests.