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Posts Tagged ‘price elasticity of supply’

Lobster for all?

Over the past few years lobster prices in Maine have tumbled. Eight years ago the price paid to fishermen was around $4.60 per pound. Today it’s around $2.20. The problem is one of booming lobster populations and the dominance of lobster in catches. Last year’s haul was double that of a decade ago and, in some waters, six times higher.

You would think that larger catches would be good news for fishermen. But prices now are so low that they barely cover variable costs. Individual fishermen fish harder and longer to bring in even bigger catches to make up for the lower price. This, of course, compounds the problem and pushes the price even lower.

So what are the answers for the fishermen of Maine? One solution is to diversify their catch, but with lobster so plentiful and other fish stocks depleted, this is not easy.

Another solution is to cooperate. The Reuters article below quotes John Jordan, a lobsterman and president of Calendar Islands Maine Lobster Co.:

‘If you had an industry that actually cooperated, you wouldn’t be bringing in more product if you couldn’t sell what you already had, right?’

Restricting the catch would require lobster distributors to cooperate and set quotas for what the fishermen would be permitted to sell. But with over 5000 fishermen, this is not easy.

Another solution is to expand the market. One way is for the distributors or other agencies to market lobster and lobster products more aggressively. For example, this year the State of Maine has established a $2 million marketing collaborative. Another solution is to find new markets.

Jordan’s company and others are frantically seeking new ways to sneak lobster into unexpected corners of the food market, from gazpacho to puff pastries and quiche.

In the meantime, for consumers the question is whether the low prices paid to the fishermen of Maine will feed through into low prices in the fishmonger, supermarket and restaurant. So far that does not seem to be happening, as the final two articles below explain.

Webcasts
US lobster fishermen’s ‘problem of plenty’ BBC News, Jonny Dymond (5/10/13)
Maine lobstermen in a pinch over low prices, record catch: Part 1, Part 2, Part 3 Aljazeera America, Adam May (11/10/13)

Articles
Something fishy is going on in the nation’s lobster capital CNBC, Heesun Wee (1/9/13)
Booming lobster population pinches profits for Maine’s fishery Reuters, Dave Sherwood (25/8/13)
Lobster’s worth shelling out for The Observer,
Rachel Cooke (21/9/13)
Clawback The New Yorker, James Surowiecki (26/8/13)
Why The Glut Of Cheap Lobster Won’t Lower Price Of Lobster Rolls Gothamist, John Del Signore (20/7/12)

Questions

  1. Why have lobster prices paid to fishermen fallen? Illustrate your argument with a demand and supply diagram
  2. What has determined the size of the fall in prices? What is the relevance of price elasticity of demand and price elasticity of supply to your answer?
  3. How is the fallacy of composition relevant to the effects on profits of an increase in the catch by (a) just one fisherman and (b) all fishermen? What incentive does this create for individual fishermen in a competitive market?
  4. What can lobster fishermen do to restore profit margins through collaborative action?
  5. In what ways is there a conflict between economics and ecology in the lobster fishing industry?
  6. How does stored lobster affect (a) the price elasticity of supply and (b) the price volatility of lobster?
  7. How could cooperation between lobster fishermen and lobster processors and distributors benefit all those involved in the cooperation?
  8. Why may restaurants choose to maintain high prices for lobster dishes for ‘psychological reasons’? Are there any other reasons?
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The battle to cut VAT for pubs, restaurants and hotels

Why are 43 companies in the pub and restaurant sector in the UK donating over a £1 million to an 86 year old Frenchman who claims to work a 70 hour week? Jacques Borel has led an interesting and varied life which has included activities such as helping the French resistance in the 2nd world war and opening the first take-away hamburger restaurant in France in 1961. In 2001 he started a campaign to get the European Union to allow member states to reduce the rate of VAT applied to food and drink sold in the pub, hotel and restaurant industry. Organisations such as JD Wetherspoon, Heineken and Pizza Hut are backing his attempts to persuade the UK government of the benefits of this policy.

VAT is paid when goods and services are purchased and is normally included in the price advertised by the seller. It generates a significant amount of money for the UK government and it is estimated that it will raise £102 billion in 2012-13 – the third biggest source of revenue after income tax and national insurance contributions. It is applied at three different rates in the UK – a standard rate of 20%, a reduced rate of 5% and a zero rate i.e. 0%. This may sound straightforward but in reality the tax is extremely complicated as previously discussed in articles on this website . For example most basic or staple items of food sold in shops are zero rated. However there are some rather bizarre exceptions. For example a packet of potato crisps is subject to the standard rate of VAT whereas tortilla chips are not. The standard rate is applied to a packet of Wotsits whereas a zero rate is applied to a packet of Skips!

The campaign headed by Mr Borel focuses on the discrepancy between the zero-rate applied to most food items purchased from a shop and the standard rate applied to food purchased in restaurants or cafes. For example, if you buy a Pizza from a supermarket then you don’t pay any tax on this purchase, whereas if you eat a pizza in a restaurant the standard 20% rate of VAT is applied. Mr Borel is lobbying the UK government to reduce the rate of VAT paid in pubs and restaurants from the standard rate of 20% to the reduced rate of 5%. One reason why so many UK companies are willing to offer him financial support is because of his success in getting governments in other countries such as Germany, Belgium, Finland and France to adopt this policy.

In a recent radio interview Mr Borel was asked to make his case for the proposed reduction of VAT in the UK. He claimed:

I have a commitment from 125 chains of hotels, restaurants and independents to use 60% of the reduction in VAT to lower prices so that would be a 7.5% decrease in price. When you decrease price by that magnitude you will see an increase in customers of 10-12% and you will be forced to hire new staff. In our best case scenario, we plan to create 670,000 jobs in three years.

When asked in another interview why the hospitality sector should be favoured more than others he replied that:

It would create more jobs in a minimal amount of time…you cannot do that with any other industry.

One obvious drawback of the policy would be the loss of revenue for the UK government. Some estimates have suggested that the loss of VAT receipts would be between £5.5 and £7.8 billion. However it has been claimed that over time the impact of the change on government finances would be zero. In response to the proposed tax cut a Treasury spokesman commented:

Any reduced rates would make a significant impact on revenue and, as a significant proportion of spending in these areas is by UK residents, any increase in activity in these areas would largely be at the expense of other consumer spending.

Webcast
Jacques Borel: VAT cut for pubs Morning Advertiser on YouTube (18/5/11)

Articles
Industry VAT campaigner Jacques Borel appears on Radio Four’s Today and Radio Five Propelinfo (24/4/13)
French veteran in fight to cut pub VAT Financial Times, Christopher Thompson (5/6/12)
The fiscal impact of reduced VAT rates VAT Club Jobs (22/4/13)
Pub and restaurant groups pay 86-year-old Frenchman £1m to convince UK government to cut VAT The Mail on Sunday, Sarah Bridge (20/4/13)
French veteran seeks British jobs boost with VAT Reuters (17/1/13)

Questions

  1. In his radio interview Jacques Borel claims that if firms pass on 60% of the cut in VAT this would cause a 7.5% reduction in prices. Explain why this is the case. Clearly outline any assumptions you have made in the analysis
  2. If 60% of the reduction was passed on by firms through lower prices, what do you think would happen to the money generated from the other 40% of the reduction?
  3. Using a demand and supply diagram illustrate the proposed reduction in the rate of VAT on the hospitality industry. Make sure your diagram is drawn in such a way that it clearly illustrates producers passing on 60% of the tax reduction in the form of lower prices.
  4. Assuming that the hospitality industry was very competitive, what impact would a reduction in VAT have on consumer surplus, producer surplus and deadweight welfare loss?
  5. Explain any assumptions you have in your answer to question 3 about the price elasticity of demand and supply.
  6. Using the figures provided in the radio interview is it possible to calculate the price elasticity of demand. Try making the calculation and clearly explain any assumptions you have made.
  7. Explain why the reduction in VAT might have no net effect on government finances in the long run?
  8. What factors determine the price elasticity of supply? What assumption is Mr Borel making about the price elasticity of supply in the hospitality industry compared to other industries when he makes the claim that jobs would be created quickly?
  9. Outline some of the arguments against cutting the rate of VAT.
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A 3p delay?

Increases in the cost of living over the past few years have put many families under financial pressure. One of the main factors that has been hurting households is the price of petrol and diesel. Road fuel duty was due to be increased last August, but the Chancellor delayed it in June. However, a planned 3p rise in duty by the Coalition, which has faced rebellion from numerous MPs may now be delayed further, following a hint from the Treasury.

The government has said that it will do everything it can to support struggling families with the cost of living and this has led many to conclude that in the Autumn Statement, the Chancellor will delay the planned 3p rise. Labour was defeated in its efforts to force a delay of the proposed 3p duty rise, as Tory bankbenchers were given this hint that the Treasury would decide to delay the increase anyway. The Economic Secretary to the Treasury said that fuel duty is part of the government’s strategy to help cut the cost of living. He commented that fuel duty was 20% lower in real terms compared to March 2000, when it was at its peak.

If we had continued with the policies of the previous government, quite simply prices would be higher, fuel would be 10p more expensive per litre. I know some will call for a further freeze in fuel duty today. I can assure them this government understands the financial pressures hard-working families are facing. Subject to the constraints of the public finances, this government is determined to help families with the cost of living.

A key economic question to consider is why is fuel one of the products that is frequently taxed? When a tax is imposed on a product, its price will rise and as the law of demand tells us, this will cause people to purchase less of it. But, what is so special about petrol? Why do people continue to purchase petrol even when its price rises? The following articles consider the concerns surrounding the 3p fuel duty rise.

Treasury to defer planned increase in fuel duty The Guardian, Nicholas Watt (13/11/12)
Asda chief Andy Clarke urges scrapping fuel duty rise BBC News (15/11/12)
Fuel Duty: Labour to force vote to delay 3p rise The Guardian, Helene Mulholland (12/11/12)
Fuel duty delay called for by Which? BBC News (11/11/12)
Fuel Duty: Government may still axe increase Sky News (13/11/12)
Chancellor heads off fuel duty rebellion Financial Times, George Parker (12/11/12)
Osborne pressed to shelve fuel duty rise Financial Times, George Parker (8/11/12)
Planned 3p petrol increase could be abandonedThe Telegraph, Christopher Hope (11/11/12)

Questions

  1. Why is petrol a good that is taxed so heavily?
  2. Illustrate the impact of a tax on petrol using a demand and supply diagram. Explain what happens to the equilibrium price and quantity.
  3. Which factors will make the change in price and quantity relatively larger or smaller? Think about how elasticity is relevant here.
  4. What other factors have contributed towards the increased cost of living over the past few years?
  5. Which factors in particular would make a January rise in fuel duty especially painful for many families?
  6. What are the arguments both for and against delaying the 3p rise in duty?
  7. According to the Economic Secretary to the Treasury, fuel duty is 20% lower in real terms. What does this actually mean?
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Taxing fatty products

The problem of obesity and healthy eating is a growing problem in many countries and governments have long been looking into designing policy to tackle this issue.

Some have gone for healthy eating campaigns and policies to encourage pregnant women to eat better, but one government took it a step further and introduced a Fat Tax. In October 2011, the Danish government introduced a tax on foods that are high in saturated fat in a bid to reduce consumption of these goods. However, this policy is now to be abolished.

The Fat Tax introduced by the government imposed a surcharge on foods that contained more than 2.3% saturated fat. Numerous products were affected, including meats, dairy and as expected – processed foods. The policy was criticised by scientists who said that saturated fat was the wrong target and perhaps they were proved right, but the government’s u-turn, which will now see the tax being abolished. The tax had gradually increased food prices throughout the country and authorities said that it had even put Danish jobs at risk.

With food prices much higher in Denmark with the tax, consumers switched from buying domestically produced goods to crossing the border into Germany and purchasing their cheaper food. This undoubtedly had an adverse effect on the Danish economy, as it represented a cut in consumer expenditure. Perhaps it also helps to explain Germany’s strong economy – it was feeding 2 nations! The Danish tax ministry said:

‘The fat tax and the extension of the chocolate tax — the so-called sugar tax — has been criticised for increasing prices for consumers, increasing companies’ administrative costs and putting Danish jobs at risk … At the same time it is believed that the fat tax has, to a lesser extent, contributed to Danes travelling across the border to make purchases … Against this background, the government and the (far-left) Red Green Party have agreed to abolish the fat tax and cancel the planned sugar tax’

Once the tax is abolished, other policies will need implementing to tackle the problem of obesity and encourage healthy eating, as it continues to be a big problem in this and many other countries. The following articles consider this problem.

Denmark to scrap world’s first fat tax Associated Press (10/11/12)
Denmark to abolish tax on high-fat foods BBC News (10/11/12)
Fat tax repealed The Copenhagen Post (10/11/12)
Businesses call fat tax a failure on all fronts The Copenhagen Post, Ray Weaver (10/11/12)

Questions

  1. Illustrate the effect of a tax being imposed on a diagram. What happens to equilibrium price and quantity?
  2. According to Danish authorities, consumers didn’t change their consumption habits with the tax. What does this suggest about the PED of these products?
  3. How does the amount of tax revenue generated vary with the price elasticity of demand and supply?
  4. What other policies could be implemented to encourage healthy eating?
  5. Why did this fat tax lead to higher food prices?
  6. Explain the way in which such a tax could adversely affect the Danish economy. Does this justify its removal?
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Explosion in demand for gum powder

Induced hydraulic fracturing or “fracking”, is a technique used to make fractures in shale beds, normally deep underground, through the injection of liquids under high pressure. The idea is to release oil or gas. Fracking has transformed the oil industry by allowing vast reserves to be tapped.

Although the main ingredient of the fracking liquid is water, it is also necessary to include sand and a gelling agent to increase the viscosity of the liquid and bind in the sand. The commonest gelling agent is guar gum, a gel made from powdered guar seeds, which are grown in the semi-desert regions of India and Pakistan. Guar gum is also widely used in the food industry as a binding, thickening, texturising and moisture control agent.

With the rapid growth in fracking, especially in the USA, the demand for guar gum has rocketed – and so has its price. In just one year the price of guar beans, from which the seeds are extracted, has risen ten fold from about 30 rupees (about 34 pence) to around 300 rupees per kilo. This has transformed the lives of many poor farmers. Across the desert belt of north-west India, fields are being planted with guar.

But will it last? What will the oil and gas extraction companies do in response to the higher price? What will the food industry do? What will happen to the demand and supply of guar gum over the longer term? Is it risky for farmers in India and Pakistan to rely on a single crop, or should they take advantage of the high prices while they last? These types of questions are central to many mono-crop economies.

Webcast
The little green bean in big fracking demand CNN, Mallika Kapur (10/9/12)

Articles
Frackers in frantic search for guar bean substitutes Reuters, Braden Reddall (13/8/12)
After first-half surge, US drillers find respite in guar wars Reuters (20/7/12)
Guar Gum Exports From India to Drop on Halliburton Stocks BloombergBusinessweek, Prabhudatta Mishra (3/9/12)
Frackers Seek Guar Bean Substitutes The Ithaca Independent, Ed Sutherland (13/8/12)
Synthetic Fracking Ingredient to Replace Guar Bean Greener Ideas, Madison E. Rowe (15/8/12)
From emu farms to guar crops: Why the desert is fertile for Ponzi schemes The Economic Times of India, Vikram Doctor (10/9/12)
Guar gum replacer cuts cost by up to 40% Food Manufacture, Lorraine Mullaney (4/9/12)
Less Guar Needed: TIC Gums Introduces Ticaloid Lite Powder TIC Gums (27/8/12)
Immediate Supply of Guar Gum Available in the US PRLog (1/9/12)

Questions

  1. Why have guar bean, powder and gum prices risen so rapidly? Use a demand and supply diagram to illustrate your answer.
  2. How is the price elasticity of supply of guar likely to differ between the short term and the long term? What will be the implications of this for guar prices and the livelihood of guar growers?
  3. How is the price elasticity of demand for guar likely to differ between the short term and the long term? What will be the implications of this for guar prices and the livelihood of guar growers?
  4. What would you advise guar growers to do and why?
  5. What is the role of speculation in determining the price of guar?
  6. What is a ‘ponzi scheme’? Why is the ‘desert so fertile for ponzi schemes’? (Note that the symbol for a rupee is Rs or ₹, that 100,000 rupees are referred to as 1 Lakh and that 100 Lakh are referred to as 1 Crore.)
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Food prices

With droughts and poor harvests in both North America and in Russia and the Ukraine, there are worries that food prices are likely to see sharp rises in the coming months. This is clearly bad news for consumers, especially the poor for whom food accounts for a large proportion of expenditure.

But it’s also bad news more generally, as higher food prices are likely to have a dampening effect on the global economy, struggling to recover from five years of low or negative growth. And it’s not just food prices. Oil prices are rising again. Since mid June, they have risen by nearly 25%. This too is likely to have a dampening effect.

Another contributing factor to rising food prices is a response, in part, to rising oil prices. This is the diversion of land from growing food to growing crops for biofuels.

G20 countries held a conference call on 28 August to discuss food prices. Although representatives decided against an emergency meeting, they agreed to reassess the situation in a few weeks when the size of the US harvest would be clearer. If the situation proved as bad as feared, then the G20 would call an emergency meeting of the Rapid Response Forum, to consider what could be done.

But is the sole cause of rising food prices a lack of production? Are there other problems on the supply side, such as poor distribution systems and waste? And what about the role of demand? How is this contributing to long-term increases in food prices? The articles consider these various factors and what can be done to dampen food prices.

Articles
G20 points to ‘worrying’ food prices Financial Times, Javier Blas (28/8/12)
US food prices to surge on drought Gulf News(30/8/12)
Best to get used to high food and energy prices – they’re here to stay The Telegraph, Jeremy Warner (29/8/12)
Feeling a drought The Economist (14/8/12)
Q&A: World food and fuel prices BBC News (14/8/12)
G20 considers global meeting as food prices rise BBC News (28/8/12)
Biofuels and Food Prices (direct link) BBC ‘In the Balance’ programme (25/8/12)
U.N. body urges G20 action on food prices, waste Reuters, Patrick Lannin (27/8/12)
Ethanol industry hits back over food price claims EurActiv (28/8/12)
The era of cheap food may be over Guardian, Larry Elliott (2/9/12)

Data
Food Price Index Index Mundi

Questions

  1. Why have food prices been rising in recent weeks?
  2. Use a demand and supply diagram to demonstrate what has been happening to food prices.
  3. What determines the price elasticity of demand for wheat? What might this elasticity vary over time?
  4. What is the role of speculation in determining food prices?
  5. Illustrate on an aggregate demand and supply diagram the effect of a commodity price shock. What is likely to be the policy response from central banks?
  6. What determines the price elasticity of supply of food in (a) the short term and (b) the long term?
  7. What determines the cross price elasticity of supply of food to the price of oil? Is the cross price elasticity of supply positive or negative?
  8. What can governments do to reduce food prices, or at least reduce food price inflation?
  9. What benefits may come from higher food and fuel prices over the longer term?
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Oil slipping

Oil prices have been falling in recent months. By early June they had reached a 17-month low. The benchmark US crude price (the West Texas Intermediate price) fell to $83.2 at the beginning of the month, and Brent Crude (the North Sea reference price for refining into petrol) fell to $97.7 (see chart). (For a PowerPoint of the chart below, click here.)

At the same time various commodity prices have also been falling. The IMF all commodities price index has fallen by 7.2% over the past 12 months and by 6.2% in May alone. Some commodities have fallen much faster. In the 12 months to May 2012, natural gas fell by 44%, wheat by 25%, lamb by 37%, Arabica coffee by 36%, coconut oil by 45%, cotton by 47%, iron ore by 23% and tin by 29%.

Although part of the reason for the fall in the price of some commodities is increased supply, the main reason is weak world demand. And with continuing problems in the eurozone and a slowdown in China and the USA, commodity price weakness is likely to continue.

So is this good news? To the extent that commodity prices feed through into consumer prices and impact on the rate of inflation, then this is good news. As inflation falls, so central banks will be encouraged to make further cuts in interest rates (in the cases where they are not already at a minimum). For example, the Reserve Bank of Australia cut its cash rate last week from 3.75% to 3.5%. This follows on from a cut from 4.25% on 1 May. In cases where there is no further scope for interest rate cuts (e.g. the US Federal Reserve Bank, whose interest rate is between 0% and 0.25%), then the fall in inflation may encourage a further round of quantitative easing.

But falling commodity prices are also a reflection of bad news, namely the low economic growth of the world economy and fears of turmoil from a possible Greek exit from the euro.

Update
A day after this was written (9/6/12), a deal was agreed between eurozone ministers to provide support of up to €100 billion for Spanish banks. This helped to reduce pessimism about the world economy, at least temporarily. Stock markets rose and so too did oil prices, by around 1%. But if pessimism increases again, then the fall is likely to resume.

Articles
Oil prices hit a 17-month low on China slowdown fears BBC News (8/6/12)
Oil gives up gains without signs of Fed move BloombergBusinessweek, Sandy Shore (7/6/12)
Oil Heads for Longest Run of Weekly Losses in More Than 13 Years BloombergBusinessweek, (8/6/12)
Gold plunges as Bernanke gives no hint of stimulus Live5News(7/6/12)
Oil Price Tumbles Below $83 on Weak Economy Money News(8/6/12)
World food price index expected to fall for May Reuters(6/6/12)
Oil price losing streak continues Guardian, Julia Kollewe (8/6/12)

Data
Spot fuel prices US Energy Information Administration
Commodity Prices Index Mundi
Crude Oil Price Index Index Mundi

Questions

  1. Why have crude oil prices fallen to their lowest level for 17 months?
  2. How can the concepts of income elasticity of demand, price elasticity of supply and price elasticity of demand help to explain the magnitude of the fall in crude oil prices?
  3. Would a fall in inflation linked to a fall in commodity prices be a fall in cost-push or demand-pull inflation? Explain.
  4. What are the macroeconomic implications of the fall in crude oil prices?
  5. What factors are likely to have significant impact on crude oil prices in the coming months
  6. Why is it difficult to predict crude oil prices over the coming months?
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That’s one deficit that’s been reduced

The UK’s trade deficit narrowed in March to £2.74bn from £2.95bn in February. The goods deficit fell just slightly to £8.56bn from £8.59bn, but the services surplus rose more substantially to £5.83bn from £5.64bn.

So was this a sign of the UK economy’s relative weakness holding back the demand for imports? Or was it a sign of a recovering export sector, especially in services?

And what of the coming months? What will be the effect of a growing crisis in the eurozone on (a) the sterling exchange rate, (b) the rate of economic growth outside the UK and (c) UK economic growth? And what will be the effect of these on the demand for imports and exports and on the trade balance? The following articles examine the issues.

(For a PowerPoint of the above chart, click on the following link: Balance of trade)

Articles
UK goods trade deficit stable as exports to non-EU countries rebound Reuters (15/5/12)
UK trade deficit narrows in March to £2.7bn BBC News (15/5/12)
Exports close UK trade deficit Guardian (15/5/12)
First trade surplus in cars since 1976 The Telegraph, Emma Rowley (15/5/12)
UK trade deficit narrows in March Fresh Business Thinking, Marcus Leach (15/5/12)

ONS Release
UK Trade, March 2012 ONS Release (15/5/12)

Questions

  1. Distinguish between the balance on trade in goods, the balance of trade and the balance on current account.
  2. Why did the UK’s trade deficit fall in March 2012?
  3. Why did the UK experience its first trade surplus in cars since 1976?
  4. What is likely to happen to the UK’s balance of trade in the coming months? How is the income elasticity of demand for UK exports and imports relevant to the answer?
  5. What has been happening recently to the sterling exchange rate? How will this impact on the UK’s balance of trade? How will the size of this impact depend on the price elasticity of demand and supply for imports and exports?
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Riding the commodities Big Dipper

Anyone investing in commodities over the past few weeks will have been in for a bumpy ride. During the first part of 2011, commodity prices have soared (see A perfect storm brewing?). This has fuelled inflation and has caused the Bank of England to revise upwards its forecast for inflation (see Busy doing nothing see also Prospects for Inflation).

But then in the first week of May, commodity prices plumetted. On the 5 May, oil prices fell by 7.9% – their largest daily amount since January 2009. Between 28 April and 6 May silver prices fell from $48.35 per ounce to just over $33.60 per ounce – a fall of over 30%. And it was the same with many other commodities – metals, minerals, agricultural raw materials and foodstuffs.

Many financial institutions, companies and individuals speculate in commodities, hoping to make money buy buying at a low price and selling at a high price. When successful, speculators can make large percentage gains in a short period of time. But they can also lose by getting their predictions wrong. In uncertain times, speculation can be destabilising, exaggerating price rises and falls as speculators ‘jump on the bandwagon’, seeing price changes as signifying a trend. In more stable times, speculation can even out price changes as speculators buy when prices are temporarily low and sell when they are temporarily high.

Times are uncertain at present. Confidence fluctuates over the strength of the world recovery. On days of good economic news, demand for commodities rises as people believe that a growing world economy will drive up the demand for commodities and hence their prices. On days of bad economic news, the price of commodities can fall. The point is that when undertainty is great, commodity prices can fluctuates wildly.

Articles
Commodities plunge: Blip or turning point? BBC News, Laurence Knight (6/5/11)
Commodity hedge fund loses $400m in oil slide Financial Times, Sam Jones (8/5/11)
Commodities: ‘epic rout’ or the new normal? BBC News blogs: Stephanomics, Stephanie Flanders (6/5/11)
Commodities Still a Bubble – But Prices May Continue to Rise Seeking Alpha, ChartProphet (9/5/11)
When a sell-off is good news The Economist, Buttonwood (6/5/11)
Gilt-edged argument The Economist, Buttonwood (28/4/11)
Commodities: What volatility means for your portfolio Reuters blogs: Prism Money (9/5/11)
Gold, silver rise again on debt, inflation concerns Reuters, Frank Tang (10/5/11)
Commodities After The Crash, No Way But Up The Market Oracle, Andrew McKillop (9/5/11)
Outlook 2011:Three Dominant Factors Will Impact Precious Metals in 2011 GoldSeek (9/5/11)
Energy bills set to rise sharply next winter, Centrica warn Guardian, Graeme Wearden (9/5/11)
Dollar triggered commodities ‘flash crash’, not Bin Laden The Telegraph, Garry White, and Rowena Mason (9/5/11)
The outlook for commodity prices Live Mint@The Wall Steet Journal, Manas Chakravarty (11/5/11)
Three ways to play the next commodities bubble Market Watch, Keith Fitz-Gerald (11/5/11)

Data
Commodity Prices Index Mundi
Commodities Financial Times
Commodities BBC Market Data

Questions

  1. Why did commodity prices fall so dramatically in early May, only to rise again rapidly afterwards?
  2. Why do commodity prices fluctuate more than house prices?
  3. What is the relevance of price elasticity of demand and supply in explaining the volatility of commodity prices?
  4. Under what circumstances is speculation likely to be (a) stabilising; (b) destabilising?
  5. To what extent are rising commodity prices (a) the cause of and (b) the effect of world inflation?
  6. If commodity prices go on rising every year, will inflation go on rising? Explain.
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Precious metals getting even more precious

In the past few weeks, the prices of gold and silver have been soaring and have hit all-time (nominal) highs. Over the past 12 months, gold has risen by 31%, while silver has risen by 149% and 64% since the start of February. Part of this reflects the general rise in commodity prices (see also). Oil is trading at around $125 per barrel, up 43% on a year ago; wheat is up 66%, maize by 114%, coffee (Arabica) by 118% and cotton by 122%.

Part of the reason for the rise in the price of precious metals, however, has been the weakness of the dollar. In such times, gold and silver are often seen as a ‘safe haven’ for investors.

So why have commodity prices been rising and why has the dollar been falling? What is likely to happen to the prices of gold and silver in the coming weeks and months? Is their meteoric rise set to continue? Will the ratio of the gold price to the silver price continue to fall? The following articles investigate.

Articles
Gold and silver prices jump to new record highs BBC News (25/4/11)
Gold rises 7% in April as US dollar continues to weaken BBC News (29/4/11)
Gold and silver set new highs after S&P move Financial Times, Jack Farchy (22/4/11)
Real Interest Rates Explain the Gold Price Perfectly…Too Perfectly? The Market Oracle, Andrew Butter (25/4/11)
Silver, platinum to outshine gold Toronto Sun, Sharon Singleton (25/4/11)
Gold Bugs Beware Of Fed Extermination Forbes blogs: Great Speculations, Mark Sunshine (25/4/11)
Shock and Au: Hedging Against Fear EconomyWatch, Alice Briggs (26/4/11)
Keeping an Eye on the Gold/Silver Ratio Seeking Alpha, Evariste Lefeuvre (25/4/11)

Data
Commodity Prices Index Mundi
Commodities Financial Times
Commodities BBC Market Data

Questions

  1. Why have the prices of gold and silver risen so much recently?
  2. Why has silver risen more than gold?
  3. Why may higher rates of world inflation make investors turn to precious metals for investment?
  4. How are future decisions by the Fed likely to affect the price of gold?
  5. According to the efficient capital markets theory (strong version), the current price of a commodity should already reflect all knowable factors that are likely to affect the price? Does this mean that speculative buying (or selling) is pointless?
  6. How is the price elasticity of supply of silver and gold relevant in explaining the magnitude of their price movements?
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