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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