(Cloudy), + J>(ralny), = 1

Although historic generalization exists concerning the outcome of an event, a specific current market situation may alter the probabilities. Bayes theorem combines the original probability estimates with the added-event probability (the reliability of the new infonnation) to get a posterior or revised probability,

Ft original and added-event) P(added-event)

Assume that the price changes P(up) and P(down) are both original probabilities and that an addedevent probability, such as a crop report, inventory stocks, or money supply announcement, is experted to have an overriding eflect on tomonows movement. Then

and ( and > is a iDini

Ihayttb (hcorcni nnds ihe condifional probubllJI> even if 4ie ulni and marginal pruba-

when the added news indicates up. For example, if a decline in soybean planting by more than 10°o has a 90°o chance of causing prices to move higher, then

P(added-event upj =.90

P(added-event down)= .10 would be used in Bayes theorem. SUPPLY ) DEMAND

Price is the balancing point of supply and demand. To estimate the future price of any product or explain its historic pattems, it will be necessary to relate the factors of supply and demand and then adjust for inflation, technological improvement, and other indicators common to econometric analysis. The following sections briefly describe these factors.

Demand

The demand for a product declines as price increases. The rate of decline is alwaj-s dependent on the need foi the product and its available substitutes at different price levels. In Figure 2-7a, D represents normal demand for a product over some fixed period. As prices rise, demand declines fairly rapidiy. D represents increased demand, resulting in higher prices at all levels.

Figure 2-7b represents the demand relationship for potatoes for the years 1929-1939. In most cases, the demand relationship is not a straight line; production costs and minimum demand prevent the price estimate from going to zero. On the hier end of the scale, there is a lag in the response to increased prices and a consumer reluctance to reduce purchasing even at higher prices (called inelastic demand). Figure 2-7c shows a

more representative demand curve, including extremes, where 100 represents the minimum 1 income for a producer. The demand curve, therefore, shows the rate at which a change in quantity demanded brings about a change in price.

Elasticity of Demand

Elasticity is the key factor in expressing the relationship between price and demand. It is the relative change in demand as price increases.

markiTE Ehai always

s fcir iroclud Iliai lias

LTSi III*- -•41II>I>I> ;

relallve change (%) in price

The elasticity of supply, the counterpart of demand elasticity, is a positive number, because price and quantity move in the same direction at the same time.

Equilibrium

The demand for a product and the supply of that product meet at a point of equilibrium. The current price of any commodity, or any market, represents the point of equilibrium for that product at that moment in time. Fure 2-1(1 shows a constant demand line D and a shifting supply, increasing to the right from S to S.