Technological constraints, risk and price volatility

When harvest shocks are independent and local, inter-regional trade and carry-over can be expected to stabilise prices, though not to the extent that makes price fluctuations disappear. It is easy to show that if storage and transport costs are high within a large geographical region, large swings in prices will necessarily occur even though output shocks cancel out. This will also happen over time in a single region. In that respect, technological constraints affect prices, real wages and welfare.

Consider the somewhat stylised case in which there is a stable world market price and a single market small enough not to influence world market price. The higher the transport cost to the world market from that single market, the more prices would vary in that market before it would become worthwhile to trade. The export and import points of the single market define the limits of local price volatility. There is a local minimum price which would motivate export to the world market, and that minimum price is the world market price minus transport costs. If prices fall below that level exporters in the local market will bid up prices. Likewise, there is a maximum price in the single market, which will attract imports from the world market, and that is the world market price plus transport costs.