Commodities refer to raw material used in the production of goods. They may be minerals and metals such as oil, coal, tin and cooper or agricultural hoods such as wheat, coffee, tea and sugar. Typically, commodities are used to manufacture goods and services.
Commodity markets are characterised by fluctuating prices, and producers incomes which make it difficult to plan future investment programmes and production. This is best shown in agricultural markets where the climate may effect supply in any one year. In the following diagram, initially, planned output is Qe and price Pe, leading to a planned total revenue of OPeXQe.
However, ideal weather increases supply to S1, causing price to all to P1. Supply is drawn as perfectly price inelastic, since the length of the growing season means no more can be produced until the following year. Total revenue also falls to OP1YQ1 since demand for agricultural commodities tends to be price inelastic as agricultural goods tend to be used in the production of food – a necessity. A ‘good’ harvest is a paradox, since farmers are likely to see a fall in revenue and profits.
[diagram on page 45]
The next figure shows a poor harvest due to bad weather, which decreases supply to S2, causing a rise in price to P2. Total revenue also increases to OP2WQ2 since demand for agricultural goods tends to be price inelastic. The ‘poor’ harvest is a paradox, since farmers are likely to experience a rise in revenue and profits.
[diagram on page 45]
The significance of price and income elasticity of demand
The problem of uncertain supply of commodities in any one year is compounded by the tendency for demand for these type of goods to be price inelastic. As shown previously, a good harvest will lead to a large fall in price and revenue whereas a poor harvest will lead to a larger rise in price and revenue. Consequently, farmers may make huge profits one year, and huge losses the next. It gives rise to market failure.
In the long run, the supply of agricultural commodities has increase dramatically due to major technological innovations: for example, genetically modified crops which increase yield and resistance to droughts and pests. However, the growth in demand has not been matched by a similar growth in supply. Commodities tend to be income inelastic in demand as each individual has a limited food intake. These implications point to further decreases in the real price of commodities and decreases in revenue for farmers.
However, the rapid economic growth of China and India has helped to increase the demand for commodities and so push up prices and revenues over recent years. The growth in use of biofuels has led to higher food prices – this is called composite demand.
The significance of time lags
The length of the growing season for agricultural commodities meas theere are time lags between farmers making the decision to sow seeds or raise livestock and the actual harvest of the crops or sale of meat. In a free market this may cause cyclical prices and farm incomes.