Buffer stocks refer to stocks used to stabilize the price of commodities in the market. Buffer stock schemes aim to stabilize the price of commodities through purchasing supplies of the commodities when stocks are available in excess and selling stocks of the commodities when supplies are not able to sustain the demand of the market.
Buffer stocks are usually employed by governments to exercise control of the price of agricultural products. They achieve this through buying surplus production and selling that stock storage back to the market during times when production is below the expected level. As an example, when the government buys produce during times of high production, it assists farmers in maintaining higher prices and also safeguard against unforeseen shortages or increased demands in the future. Organizations can also maintain buffer stocks of their produce.
In theory, buffer stock schemes ought to be making proceeds. This is because they purchase stocks of the commodity when price is low and sell them back to the market when the price has escalated. Nonetheless, this is not always true in practice. Truth be told, perishable products cannot be kept for an extended period of time. As such, they cannot qualify to be termed as buffer stock schemes. Furthermore, coming up with a buffer stock scheme needs a large amount of start up capital. This is because cash is required to purchase the product when prices are low and there are other costs involved in storage and administration.
It is important to note that the success of any buffer stock scheme eventually relies on its capability to rightly approximate the average price of the commodity over a period of time. And, the approximated price is the scheme’s target price. More over, it is what determines the limits of the price of the commodity.
If the target price is considerably higher than the right average price of the commodity, then it means the company will be making a lot of losses. This is because it would possibly find itself purchasing more produce than it is selling. Ultimately, the company may drain off a significant portion of its resources.
If this happens, then the price of the product will crash. The cause of this can be attributed to the dumping of the surplus stocks that have been accumulated by the company to the market. On the other hand, if the target price happens to be too low, then the average price of the commodity would rise above the limits. Eventually, it would sell more than it is purchasing and would finish up its stocks faster than it expected.