Flashcards in Chapter 10: Unstable commodity markets Deck (45):
What happens to prices on commodity markets?
They can fluctuate minute by minute and there can be periods of sharp price rises and falls.
Give some examples of commodity markets.
Wheat, rice, coffee, cocoa, copper, steel and oil.
Why are commodity markets considered to be a source of market failure?
Price volatility creates uncertainty which is not efficient.
Why does the fact that commodities are volatile in supply make them fluctuate in price more?
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.
Why does the fact that demand and supply for commodities tends to be price inelastic make them fluctuate in price more?
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.
How does demand for some commodities changing arbitrarily lead to fluctuations in price?
For instance a cold winter can significantly increase the demand for oil.
How does the fact that commodities are often traded for speculative reasons make them fluctuate in price more?
An expectation of price rises may cause increased demand from those hoping to make a capital gain causing the price to increase even further.
Which products have really volatile prices?
What is a way in which the fluctuations in prices can be smoothed out?
Through buffer stock schemes.
What do buffer stock schemes do?
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.
What are the supply curves like on a buffer stock scheme diagram?
There are two supply curves that are vertical as they are perfectly price inelastic. The supply curve furthest out represents a bumper harvest.
How are price fluctuations kept within a certain band?
There are minimum prices and maximum prices put in place.
What happens when there is a bumper harvest and the price falls below the minimum price?
Organisation buys up the distance between the minimum price and the supply curve on the left - need to draw new demand curve.
What happens when there is a bad harvest and price rises above the maximum price?
The organisation buys up the distance between the supply curve on the right and the maximum price level
Why should a buffer stock scheme be profit making?
They buy up stocks of the product when the price is low and sell them onto the market when the price is high.
What is the problem with storing perishable items?
They cannot be stored for long periods of time and can therefore be immediately ruled out of buffer stock schemes.
Why does setting up a buffer stock scheme require a significant amount of start-up capital?
Money is needed to buy up the product when prices are low.
What types of costs need to be considered in a buffer stock scheme?
High administrative costs and storage costs.
What does the success of a buffer stock scheme ultimately depend on?
The ability to correctly estimate the average price of a product over a period of time.
What does the estimate of average price determine?
The scheme's target price as well as the maximum and minimum price boundaries.
What happens if the target price is significantly above the correct average price?
The organisation will find itself buying more produce than it is selling and will eventually run out of money.
What happens to the price of the product if the target price is significantly about the correct average price?
It will crash as excess stocks built up in the organisation are dumped onto the market.
What happens if the target price is too low?
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.
What is a minimum price?
It is a legally imposed price floor below which the market price cannot fall.
What needs to happen to the minimum price if it is to be effective?
The minimum price has to be set above the equilibrium price.
Why are minimum prices set in a commodity market?
They are meant to reduce the impact of price fluctuations and there is also a time-lag problem.
What is the time-lag problem in terms of agricultural products?
Crops can take up to a year to grow and animals several years to raise.
What is the effect of the time-lag in the agricultural market?
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.
Why are fluctuating prices bad for producers?
It leads to unstable incomes.
Why are fluctuating prices bad for consumers?
Many of these goods are necessities.
What does a higher price on a minimum price scheme diagram lead to?
A higher price will lead to an extension along the supply curve and a contraction along the demand curve.
Which quantity is supplied and which quantity is demanded on a minimum price scheme?
The quantity supplied is the higher one and this applies to the quantity demanded as well.
How can you calculate the total expenditure on a commodity through a minimum price scheme diagram?
It is a rectangle. It is the area between the two quantities and the price at the equilibrium level.
Why would the government or a regulator set a maximum price?
In an attempt to prevent the market price from rising above a certain level.
What is the aim of a maximum price scheme?
To prevent the exploitation of consumers by monopoly firms.
What needs to be happen in order for the maximum price scheme to be effective?
The maximum price has to be set below the market price.
What does the price ceiling create?
A shortage or excess demand as the price has been held below the equilibrium.
What would happen if a price ceiling was set above the free market equilibrium price?
It would have no effect whatsoever on the market.
What happens to the producer and consumer surplus after a maximum price scheme?
How can the new area of consumer and producer surplus be demonstrated on the graph after a maximum price scheme?
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.
What is a shadow market?
An illegal market in which the market price is higher than the legally imposed price ceiling.
Why do shadow markets develop?
As a consequence of the resulting shortage of a maximum price scheme.
How can rationing when there is a maximum price scheme be achieved?
By allocating goods on a first-come first-serve basis.
How might suppliers allocate scarce goods?
By distributing goods only to preferred consumers.