Sixth form Conference 27th June 2006 World Commodity Prices and Markets Dr Wyn Morgan
Question: what links Chinese economic policy with a crime committed in Sinfin in June? http://news.bbc.co.uk/1/hi/england/derbyshire/5011174.stm Answer: the price of copper. Why? China is growing rapidly and demanding commodities such as copper, thus prices have risen sharply Criminals see prices rising and try to “supply” some from a community centre!
Figure 1: Copper Prices $/tonne (July ’05-June ’06) Source: BBC
Outline 1. Commodities defined 2. The main features of commodity markets 3. Price behaviour 4. Policies for commodity markets 5. Conclusions/questions
1. Commodities Defined “A commodity is something that hurts when you drop it on your big toe, or smells bad if you leave it out in the sun too long” (Barron’s 27th June 1983) Primary commodities are “natural” and have not been processed into other products What types of internationally traded primary commodities are there?
Food/Beverages Coffee, cocoa, sugar, wheat, maize, rice, bananas, beef Minerals and Metals Tin, copper, zinc, nickel, iron ore, aluminium Agricultural Raw Materials Rubber, cotton, tobacco, oilseeds, soybeans, oils (palm, groundnut) Fuels Oil, gas and coal
2. What are the Main Features of Commodity Markets? • Major share of world trade • 23% including fuels • 14% excluding fuels • Many countries export & import (see Table 1) • Most DMEs net importers (except Australia and Canada)
Demand – generally stable • Necessities (e.g. food) • Low degree of substitution • Low income elasticity for food • Inputs into manufacturing production: • Copper in construction or palladium for mobile phones • Some substitution (e.g. rubber)
Supply – can be volatile • Not just developing countries (see Table 2) • Time period for supply means short run is a long time and elasticity low e.g.: • Minerals need new mines • Coffee bushes need 7 years to mature • Effect of shocks • Permanent - new processes • Temporary - weather • http://business.timesonline.co.uk/article/0,,9065-2236557.html
Graph 1: Commodity Market with Supply Shock S2 Price S1 S3 P2 P1 P3 D Q2 Q1 Q3 Quantity
Graph 2: Commodity Market with a Demand Shift Price S P2 P1 D2 D1 Q1 Q2 Quantity
3. Price Behaviour Commodity prices exhibit two main features: 1. A high degree of volatility (see Table 3) arising mostly from supply volatility 2. Downward trend relative to manufactured goods
Do these features represent a problem? • Volatility • Input price volatility • Labour and capital costs known, other inputs not – what happens? • Who pays for this? Inflation effects? • Selling price volatility • Producer income unknown • Investment difficulties
Downward Trend • LDC producers rely on export revenues • Need manufactured goods for growth • Try to produce more to increase revenues: Y = PQ • Increase Q to offset fall in P but this causes P to fall! • Problem of dependence on a few commodities for export earnings (see Table 4)
4. Policies for Commodity Markets What do countries want? • DMEs want good supplies but with stable and “fair” (low??) prices • LDCs want increased export earnings but want them to be stable (high prices??) How can these be reconciled? By “managing” the market
International Commodity Agreements • Buyers and sellers control supply to keep prices in a stable range • Supply controlled by production limits, export quotas, buffer stocks etc
Graph 3: Price Bands in a Commodity Market Price S Pu Pe PL D Qe Quantity
International Commodity Agreements • Buyers and sellers control supply to keep prices in a stable range • Supply controlled by production limits, export quotas, buffer stocks etc • Existed for a number of commodities: sugar, coffee, cocoa, rubber, tin • All collapsed due to disagreements between the two sides
One-sided interventions • Supply control by producers (cartels) • e.g. OPEC • Controls supply by quotas and can increase prices (see 1973/4 on Figure 1) • Protection of domestic producers • e.g. Common Agricultural Policy • Use tariffs and artificial prices to raise incomes for EU farmers • Impact on world markets significant
Other Policy Issues in Commodity Markets • Development and growth concerns • Diversification of production in LDCs • Inflation in DMEs • Environmental concerns • Technological change and its effects • Market power and prices • Risk management
5. Conclusions/Questions • Commodities are important for both LDCs and DMEs • Commodity markets have stable demand but potentially volatile supply • Prices can be volatile in short run and downward trending in the long run • Intervention can affect prices but what are the welfare implications of such policies?