Price Expectations and the Welfare Gains from Price Stabilization

The gains from price stabilization are analyzed in the case where supply decisions are made before the actual market price is known and so are based on price expectations. Two expectations generating mechanisms are considered—the “adaptive” scheme and the “rational” hypothesis. In both cases price stabilization provides an overall welfare gain that is higher than when supply depends upon actual prices. The distribution of these gains among producers and consumers is shown to depend crucially upon how the expectations are generated, as well as the source and autoregressive properties of the random price fluctuations.