Chapter 10: Unstable commodity markets

Question 1

What happens to prices on commodity markets?

Answer 1

They can fluctuate minute by minute and there can be periods of sharp price rises and falls.

Question 2

Give some examples of commodity markets.

Answer 2

Wheat, rice, coffee, cocoa, copper, steel and oil.

Question 3

Why are commodity markets considered to be a source of market failure?

Answer 3

Price volatility creates uncertainty which is not efficient.

Question 4

Why does the fact that commodities are volatile in supply make them fluctuate in price more?

Answer 4

Bad weather during one season might restrict the supply of a particular crop so supply shifts to the left. A bumper harvest due to good weather will shift supply to the right.

Question 5

Why does the fact that demand and supply for commodities tends to be price inelastic make them fluctuate in price more?

Answer 5

There are often few substitutes for such products which makes demand inelastic and supply is likely to be inelastic for commodities extracted or grown in the ground.

Question 6

How does demand for some commodities changing arbitrarily lead to fluctuations in price?

Answer 6

For instance a cold winter can significantly increase the demand for oil.

Question 7

How does the fact that commodities are often traded for speculative reasons make them fluctuate in price more?

Answer 7

An expectation of price rises may cause increased demand from those hoping to make a capital gain causing the price to increase even further.

Question 8

Which products have really volatile prices?

Answer 8

Agricultural products.

Question 9

What is a way in which the fluctuations in prices can be smoothed out?

Answer 9

Through buffer stock schemes.

Question 10

What do buffer stock schemes do?

Answer 10

They seek to stabilise the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low.

Question 11

What are the supply curves like on a buffer stock scheme diagram?

Answer 11

There are two supply curves that are vertical as they are perfectly price inelastic. The supply curve furthest out represents a bumper harvest.

Question 12

How are price fluctuations kept within a certain band?

Answer 12

There are minimum prices and maximum prices put in place.

Question 13

What happens when there is a bumper harvest and the price falls below the minimum price?

Answer 13

Organisation buys up the distance between the minimum price and the supply curve on the left - need to draw new demand curve.

Question 14

What happens when there is a bad harvest and price rises above the maximum price?

Answer 14

The organisation buys up the distance between the supply curve on the right and the maximum price level

Question 15

Why should a buffer stock scheme be profit making?

Answer 15

They buy up stocks of the product when the price is low and sell them onto the market when the price is high.

Question 16

What is the problem with storing perishable items?

Answer 16

They cannot be stored for long periods of time and can therefore be immediately ruled out of buffer stock schemes.

Question 17

Why does setting up a buffer stock scheme require a significant amount of start-up capital?

Answer 17

Money is needed to buy up the product when prices are low.

Question 18

What types of costs need to be considered in a buffer stock scheme?

Answer 18

High administrative costs and storage costs.

Question 19

What does the success of a buffer stock scheme ultimately depend on?

Answer 19

The ability to correctly estimate the average price of a product over a period of time.

Question 20

What does the estimate of average price determine?

Answer 20

The scheme’s target price as well as the maximum and minimum price boundaries.

Question 21

What happens if the target price is significantly above the correct average price?

Answer 21

The organisation will find itself buying more produce than it is selling and will eventually run out of money.

Question 22

What happens to the price of the product if the target price is significantly about the correct average price?

Answer 22

It will crash as excess stocks built up in the organisation are dumped onto the market.

Question 23

What happens if the target price is too low?

Answer 23

The organisation will often find the price rising above the boundary, it will end up selling more than it is buying and it will eventually run out of stocks.

Question 24

What is a minimum price?

Answer 24

It is a legally imposed price floor below which the market price cannot fall.

Question 25

What needs to happen to the minimum price if it is to be effective?

Answer 25

The minimum price has to be set above the equilibrium price.

Question 26

Why are minimum prices set in a commodity market?

Answer 26

They are meant to reduce the impact of price fluctuations and there is also a time-lag problem.

Question 27

What is the time-lag problem in terms of agricultural products?

Answer 27

Crops can take up to a year to grow and animals several years to raise.

Question 28

What is the effect of the time-lag in the agricultural market?

Answer 28

It means that farmers have to base their decisions on how much to plant or raise and therefore sell in the future based on current prices.

Question 29

Why are fluctuating prices bad for producers?

Answer 29

It leads to unstable incomes.

Question 30

Why are fluctuating prices bad for consumers?

Answer 30

Many of these goods are necessities.

Question 31

What does a higher price on a minimum price scheme diagram lead to?

Answer 31

A higher price will lead to an extension along the supply curve and a contraction along the demand curve.

Question 32

Which quantity is supplied and which quantity is demanded on a minimum price scheme?

Answer 32

The quantity supplied is the higher one and this applies to the quantity demanded as well.

Question 33

How can you calculate the total expenditure on a commodity through a minimum price scheme diagram?

Answer 33

It is a rectangle. It is the area between the two quantities and the price at the equilibrium level.

Question 34

Why would the government or a regulator set a maximum price?

Answer 34

In an attempt to prevent the market price from rising above a certain level.

Question 35

What is the aim of a maximum price scheme?

Answer 35

To prevent the exploitation of consumers by monopoly firms.

Question 36

What needs to be happen in order for the maximum price scheme to be effective?

Answer 36

The maximum price has to be set below the market price.

Question 37

What does the price ceiling create?

Answer 37

A shortage or excess demand as the price has been held below the equilibrium.

Question 38

What would happen if a price ceiling was set above the free market equilibrium price?

Answer 38

It would have no effect whatsoever on the market.

Question 39

What happens to the producer and consumer surplus after a maximum price scheme?

Answer 39

They reduce.

Question 40

How can the new area of consumer and producer surplus be demonstrated on the graph after a maximum price scheme?

Answer 40

Take away the triangle which has its largest side as the lowest quantity extended between the supply and demand curve from the original triangle of producer and consumer surplus.

Question 41

What is a shadow market?

Answer 41

An illegal market in which the market price is higher than the legally imposed price ceiling.

Question 42

Why do shadow markets develop?

Answer 42

As a consequence of the resulting shortage of a maximum price scheme.

Question 43

How can rationing when there is a maximum price scheme be achieved?

Answer 43

By allocating goods on a first-come first-serve basis.

Question 44

How might suppliers allocate scarce goods?

Answer 44

By distributing goods only to preferred consumers.

Question 45

What is wrong with rationing?

Answer 45

It is unfair as that those who might have the greatest need for the commodity are unlikely to have their needs met.