Lecture Notes: Futures Contracts and Speculation

Introduction to Futures Contracts

• Location: Chicago Board of Trade
• Activity: Buying and selling futures contracts
• Commodities Involved: Corn, wheat, cattle, milk, lumber
• Definition: A futures contract is a legal agreement to buy or sell a particular commodity, asset, or security at a predetermined price at a specified time in the future.

How Futures Contracts Work

• Example Scenario:
  • Contract to buy corn at $600 per bushel in three months.
  • If Market Price > $600: Buyer profits by reselling at a higher price.
  • If Market Price < $600: Seller profits by buying at a lower price and selling at $600.
• Purpose: Speculation based on future price changes.

Speculation in Futures Markets

• Objective: Buy low, sell high.
• Impact: For every winner, there's an equal and opposite loser.
• Criticism of Wall Street: Seen as not contributing to society since it's engaged in speculation rather than production.

Role of Speculation in Resource Management

• Impact on Commodity Prices:
  • Expectations of future demand influence current prices.
  • Drives producers to adjust supply based on future expectations.
• Case Study: Haiti vs. Dominican Republic
  • Haiti: Weak economic institutions, failure to reach market equilibrium, deforestation.
  • Dominican Republic: Strong property rights and markets, sustainable resource use.
  • Speculation: Encourages preservation of resources for future value.

Market Function for Future Predictions

• Speculators' Role: Provide information to set expected future prices.
• Market Aggregation: Combines information to determine prices that optimize consumer and producer welfare.
• Predictive Power: Helps producers make informed decisions about long-term planning.
  • Example: Farmers using futures markets to predict future crop prices.

Case Study: Predictive Accuracy of Futures Markets

• Research by Richard Roll:
  • Found that futures prices of oranges were sensitive to weather changes.
  • Suggested improvements to National Weather Service forecasts.

Conclusion

• Importance of Futures Markets: Provide insights and predictions that guide economic decisions and resource management.
• Open Question: What other predictions can markets make?

These notes cover the significant aspects of futures contracts, the process of speculation, its societal impacts, and the role these markets play in resource preservation and economic forecasting.