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Home Field Trips Rural Life and Agriculture Tour Price Movements in Commodity Markets

Theories

Price Movements in Commodity Markets

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The prices of primary commodities such as coffee and copper sometimes show two characteristics:

1. They are prone to short term price fluctuations
2. They are inclined to exhibit a downward trend in the longer term.

Short term price fluctuations
Two models can be used to aid our understanding of why prices are often unstable.

1. A static analysis
2. A dynamic analysis

Both suggest that a supply shock caused by weather or another unplanned change in supply causes prices to fluctuate. In addition, due to the relatively price inelastic nature of the demand for many primary products the price changes are likely to be larger than if the demand for the good concerned was relatively price elastic.

One model that has been used to show price fluctuations of primary commodities is the cobweb model. A cobweb with the price fluctuations getting greater is shown in the diagram below:

The cobweb is most likely to occur where supply is fixed and depends on what happened in a previous time period. This is particularly likely with agricultural markets. In this diagram supply changes (S1, S2 and S3) and is determined by the outcome in the previous time period. As a result, prices fluctuates and in this case the fluctuations get worse and worse.

Next theory - Internal Economies of Scale >>