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Futures Markets and the Theory of the Firm Under Price Uncertainty

Gershon Feder¹; Richard E. Just^2,3; Andrew Schmitz³

¹ World Bank · ² Brigham Young University · ³ University of California, Berkeley

This paper examines the behavior of a competitive firm under price uncertainty where a futures market exists for the commodity produced by the firm. Working with the Sandmo approach, we found that production decisions depend only on the futures market price and input costs; the subjective distribution of future spot price affects only the firm's involvement in futures trading. Conditions are then determined under which a firm will either hedge, speculate by buying futures contracts, or speculate by selling futures contracts. The results indicate that an important social benefit derived from the existence of a futures market is to eliminate output fluctuations due to variation in producers' subjective distributions of future spot price.

DOI

10.2307/1884543

Volume

94 (2)

Pages

317

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