CAN SPOT AND CONTRACT MARKETS CO-EXIST IN AGRICULTURE?

New production technologies, consumers who are more discriminating, and the need for improved coordination are among the forces driving the move from spot markets to contracts. Some worry that this tendency will result in the disappearance of spot markets, or at least that they will become too thin to be of help for an efficient price discovery process. Other authors point to the reduction in welfare of independent producers resulting from contracting in oligopsonistic industries. While a large body of literature is available tackling the contract versus spot market decision, much less is known about the reasons that lead to procurement in both markets. This paper provides a very simple model to study how fundamental economic factors influence the contracting behavior of farmers and processors. In the model, processors contract upstream into a competitive industry (farmers). We find that participation in both markets arises as a Nash equilibrium for a range of contract prices. We use numerical methods to examine the effects of fundamental economic factors on the relative size of the spot and contract markets and the effect of contract price on the relative profitability of farmers and processors