The buffer stock scheme is a scheme where an organisation buys and sells in the open market so as to maintain a minimum price for a product. It is used mainly on primary products such as agriculture, mining, and etc.
It was designed to even out price fluctuations for producers and to maintain production. An intervention price is set, which is a minimum fixed price. Minimum prices are usually set to help producers increase their incomes. The government may decide that the free market price for wheat is too low a price for farmers to receive and therefore set a minimum price. (fig. 1)This will result in an increase in supply of wheat because farmers can receive higher prices for it. This increase in price then leads to a decrease in demand so there will be an excess supply. Because of this excess, the government has to intervene in the market in order to not let prices for wheat drop to below the minimum price. One such way is through the buffer stock scheme. .
Fig. 1) Minimum Price for Wheat.
The government may set an intervention .
price for wheat and therefore increase the .
free market price of P1 to P2. This then.
leads to an increase in supply from Q1 to Q3. But due to the increase in price, demand.
falls from Q1 to Q2 so there is an excess.
supply of Q2Q3.
In the case of wheat, when free market price is below the intervention price, the buffer stock agency that is funded by the government will buy in the wheat (which is called the buffer stock) and when the free market price goes above the intervention price, they will resell the wheat and therefore push down the price down to the intervention price. .
Buffer stock schemes are not very common because they take a considerable amount of capital to set up. However, it usually doesnt work like the way it was meant to work because since producers generally prefer to set the intervention price high above the average market price, it is likely that the price will often fall below the intervention price since consumers are probably not willing to pay such high prices.