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Price Volatility in Markets
AS Microeconomics November 2009
World Commodity Prices
Food Price Index
High food prices still a
concern
Future Food Supply
Discussed
Causes of price volatility – demand-side factors
1. Demand may be highly cyclical (high income elasticity)
2. Peak/off-peak demand3. Seasonal changes in demand4. Speculative demand5. Low price elasticity of demand
Causes of price volatility – supply-side factors
1. Unstable conditions of supply2. Changes in actual versus planned
supply3. Artificial limits on supply e.g. Export
quotas4. Low price elasticity of supply
Crude oil prices
Q&A on volatile oil prices
Demand is main SR driver of oil prices
Oil falls as demand set to
drop
And perhaps in the long run too!
Basic supply and demand analysis
Price
Quantity
D1
S1
Q1
P1
An increase in market demand
Price
Quantity
D1
S1
Q1
P1
D2
P2
Q2
Rise in demand with an inelastic supply –causes steep rise in
market price.
Note too the low elasticity of demand
Increase in supply
Price
Quantity
D1
S1
Q1
P1
D2
P2
Q2
S2
P3
Q3
Cocoa Prices
Cocoa prices reach 23 year
high
Agricultural products have a low SR elasticity of supply
Price
Quantity
D1
S1
Q1
P1
Agricultural products tend to have a low price
elasticity of supply
1/ Growing seasons2/ Time needed to make investments and begin production3/ Costs of storing products
And are vulnerable to supply shocks
Price
Quantity
D1
S1
Q1
P1
Adverse weather can cause actual supply to <
planned supply
Fall in supply → fall in stocks → rise in price
Decline in stocks may cause speculative
activity
S2
Q2
P2
World rice prices
Thailand’s misguided rice
policy
Rice price hike hits Vietnam
Consequences of price volatility (1)• Risk:
– Makes incomes and profits for producers unpredictable– May limit capital investment spending from producers
• Poverty and Resource Allocation– Falls in prices and incomes can cause deep poverty for farming
regions– And cause increases in unemployment – a waste of scarce
resources– Incentives - Collapsing prices may cause crop switch to drug
production– Steep rise in prices can lead to food poverty, malnutrition and
premature death in countries where per capita incomes are low
Consequences of price volatility (2)• Trade (Balance of Payments) and GDP growth
– Big swings in prices affect revenues for exporters– Affecting their ability to finance imports of food and
technology– Declining export prices damages GDP growth – negative
multiplier effects
• Price volatility has economic and social consequences
Attempts to stabilise pricesDifferent options for government intervention1. Price controls
– Price floors to protect farmers’ incomes– Price ceilings to protect consumers
2. Trade controls– Use of export quotas to maintain domestic supply– Changes in import tariffs
3. Commodity price stabilisation schemes– Buffer stock schemes
• These intervention options are covered in separate presentations
BBC resources on food prices
Examples of price volatility
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