Futures Markets and the Theory of the Firm Under Price Uncertainty

Authors:
  • GFGershon Feder
    Gershon Feder
  • RJRichard E. Just
    Richard E. Just
  • ASAndrew Schmitz
    Andrew Schmitz
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Abstract
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.