The Factors Influencing the Volatility of Agricultural Commodity Prices - Essay Example

Discuss the factors influencing the volatility of agricultural commodity prices and the mechanisms available for governments and businesses to managethese price movements. Introduction The volatility of commodity prices has always been an issue of importunate gravity in the world. Since recent past, different economies of the world have experienced numerous crunches and depressions and prices of commodities were one of the paramount victims of these crisis. Gone is the time when the commodity prices were predictable for several years and people could buy or sell things at adumbrating cost. The following paper will inquest and scrutinize the factors which are responsible for the volatile behavior of commodity process in the agricultural sector. Agricultural commodities are the hub of the world economy as every thing is dependent on the agricultural products especially in third world (Goodman, 1997). Different data sources and analysis techniques will be deployed in order to depict the exact factors responsible for the fluctuations in the agricultural commodities. Discussion The first and foremost factor in the fluctuations in the commodity prices of the agricultural sector is the increasing gap between the demand and the supply. The demand has been increasing every day in third world countries, many parts of Asia and China whereas there has been no emphasis on the production part which is basically focused on the first world countries (Johnston & Mellor, 1961). Similarly, numerous macroeconomic and financial factors are censurable for the metamorphosis of the prices of commodities in the agricultural sector. In the similar fashion, high novelty and revision in the dollar prices due to the global shifts in the political and financial crisis is also responsible for these rate changes and imbalance in the prices. The reason behind this factor is that most of the agricultural commodities have their prices finalized in terms of US dollars and all the prices are calculated and denominated in the form of dollars (Hernandez, 2012). According to Charlebois and Hamann (2010), the prices of main agricultural commodities like soybean and wheat experienced a rise up to 14% because of the decline in value of the US dollar. Therefore any effect other value of market price o dollar will directly affect the prices of agricultural commodities everywhere in the world. There are many other factors on which the experts have a split. For example, Gilbert and Morgan (2010) and De Schutter (2010) said that the fluctuations in the local agricultural commodities and food items are caused by irresponsible speculations and bad rumors culture which can bring the market up and down within no time. The stock market example has been used by them as an analogy but there is a difference o opinion in this theory and many experts like Irwin and Sanders (2010), do not consider this theory conforming the practical approach. According to a study, the extent of fluctuations in the prices o agricultural commodities have been recorded as the highest in past nineteen years and this is a very alarming measure indeed because of these high ate o fluctuations, the global economies are taking new turns. Other minute factors include climate changes, unintended wars, disasters and cultural collapses throughout the world. Another very important factor behind the dramatic rise of agricultural commodities is the integration initiatives of the energy and agricultural markets in many production based countries. For example, in America, the prices for the paramount and importunate agricultural commodities like soybean, corn and wheat rose up with a rate of around 148, 123, and 154 percent respectively. According to experts in America, around 70 to 75 percent of increase in the agricultural commodities is due the engendering and production of bio fuel and diesel based materials. The periodic abatements in the hedging efficiency is also a very conspicuous and considerable factor in the changes of prices agricultural commodities. For example, the hedging efficiency for the corn products decreases by 87 to 28 percent, and there was a 78 to 26 decline in the hedging efficiency value of soybeans. The roles of macroeconomic variables are also very much important in determining the commodity prices of agricultural sector. Similarly, the merging of energy products and fuel items with the industry of agricultural commodities is a very important cause of the price volatile issues (Riley, 2012). There has been an increasing use of oil products in the making of wheat, soya bean and corn items. According to a survey, 52 percent o rise in the cost of these three agricultural commodities were due to the rise in oil prices. Similarly, the major commodities in the agricultural sector experienced a high price with the rate of around 12 and 15 % in the year 2008 due to the rise in crude oil prices all over the world. Charlebois and Hamann made a prediction that there will be around 10 percent rise in the prices of soybeans and corn and a rise of around 7 percent in the prices of wheat for the time period of around 2008 up to 2011 an this prediction was proved to be true. The prediction was linked with the overall trends in the increasing rates o crude oil. According to a report by Food Agriculture Organization (FAO 2008), there are mainly two reasons which are primarily responsible for the correlation between the volatility of the prices of agricultural commodities and crude oil. The report suggested that as there is a high relation between the production process of the wheat, soybean and corn products and the oil derivatives, that is why any fluctuation in the oil price cause a direct effect on the price of these commodities. Secondly, stock to use ratios are effected very badly when there is a competition between use of soybeans and other oil products. Thus the difference between demand and supply cause a great fluctuation in the global prices (Tyner, 2010). There is also another actor which affects the volatile behavior of the prices of the agricultural commodities and that is the macroeconomic effects on the global economy. Apparently there seems to be no relation between the macro economic variables like inflation GDP growth, exchange rates foreign exchange investments and industrial productions but experts suggest otherwise. Some experts say that the magnitude of volatile behavior increases with the increase in inflation but decreases with a decrease in risk-free rate (Ellison & Yates, 2007). The Ricardian model also supported this idea o trade theory and said that the labor is the production can only run on the labor and this trade off can be negotiated by making some kind of difference between two countries (Dornbusch et al, 1977). The fact endowment process is also explained in the traditional theory as a part of competitive advantage and depicted that how a country can exhaust its resources, labor and technological expertise in order to enjoy the comparative advantage in the business process. Similarly, Theory of absolute advantage was put forward by Adam Smith 1776; who said that there should be absolutely no role of the governments identifying and fixing of the market prices rather the focus of the market should determine all the variables. He said that the producers in the market should put more and more focus on the production process of the product or services as this will increase the overall profit graphs. The prices should also by in synchronization of local market prices. This suggests that only some countries with absolute advantages can benefit from international trade. (Smith, 2003) Conclusion There are numerous factors affecting the commodity prices and the world powers should pay heed to control the volatile behavior of these prices in order to sustain the economy of the world. Asia and many other places are totally dependent upon the agricultural commodities and there is a great need to reduce the volatile structure of these prices in order to develop new economic hubs. The overall political situation is also necessary to remain calm because wars in different countries are a threat to agricultural commodities. References Charlebois, P., & Hamann, N. (2010). The Consequences of a Strong Depreciation of the US Dollar on Agricultural Markets. Economic and Market Information. De Schutter, O. (2010). Report submitted by the Special Rapporteur on the right to food. United Nations Human Rights Council. Dornbusch, R., Fischer, S., & Samuelson, P. A. (1977). Comparative advantage, trade, and payments in a Ricardian model with a continuum of goods. The American Economic Review, 823-839. Ellison, M., & Yates, T. (2007). Escaping volatile inflation. Journal of Money, Credit and Banking, 39(4), 981-993. Gilbert, C. L., Morgan, C. W., Gilbert, C. L., & Morgan, C. W. (2010). Food price volatility. Philosophical Transactions of the Royal Society B: Biological Sciences, 365(1554), 3023-3034. Goodman, D. (1997). Globalising food: agrarian questions and global restructuring. Routledge. Hernandez, D. J. G. (2012). Factors Influencing Price Volatility on Soybeans Futures Prices (Doctoral dissertation, Louisiana State University). Johnston, B. F., & Mellor, J. W. (1961). The role of agriculture in economic development. The American Economic Review, 51(4), 566-593. Riley, G. (2012) Price volatility in markets. [online] Available at: http://www.tutor2u.net/economics/revision-notes/as-markets-price-volatility.html [Accessed: 8 Jan 2013]. Sanders, D. R., Irwin, S. H., & Merrin, R. P. (2010). The adequacy of speculation in agricultural futures markets: Too much of a good thing?.Applied Economic Perspectives and Policy, 32(1), 77-94. Smith, F. A. (2003). Adam Smith, 1776. Theories of social order: a reader. Tyner, W. E. (2010). The integration of energy and agricultural markets.Agricultural Economics, 41, 193-201. Evaluate ‘traditional trade theory’ and ‘new trade theory’ as explanations of inter-industry and intra-industry trade. Introduction Traditional trade theories point to the benefits of international trade, with resource reallocation that result from specialization permitting a country to enjoy a higher level of income and consumption than would otherwise be possible. The classical trade theory limits the country to fix the prices and get only static gains whereas today is the era o dynamic gains and one product can have different price at different location around the world. The cost factors are changed by variables of locality each producer should have the right to inculcate the cost of production in the overall profit he is getting from the customer. The classical models of trade theory also diminish the competition between those countries that are at par with each other and only repay the trade routes between those countries having vast economical differences and supply chain diversity (Myint, 1958). Discussion  Heckscher–Ohlin models supporting the traditional trade theory were clinging to the conventional means of trade in which most emphasis is given on the comparative advantage. Traditional trade models are perfectly in accordance with the inter-industrial trade in which local level markets are targeted and comparative advantage is gained while exploiting the cultural, technological and market differences among different countries. The traditional trade theory comprised of taking the absolute and comparative advantage for example, if two persons are working on the same task and person A is hired on 200$ per hour whereas person B is hired at 150$ per hour then according to traditional trade models, the person A has a comparative advantage over B. Another example can depicts it relation between inter industrial trades. (Leamer & Levinsohn, 1995) The new trade theory is an extension of the existing theoretical models as the conventional models were becoming obsolete after the industrial revolution. The economy cannot be built solely on the idea that we should exploit the economic or technological differences between the two countries rather we should focus on the return to scales concept. This gave rise to intra industry market and a huge boost to the return to scale focused business orientations. The concept of return to scales means that all the phases in business production are inter-related and one variable can directly affect the other one (Mtigwe, 2006). For example if the production inputs are increased two times and quality of the input material is improved in the same order then the end product will be improved twice. Similarly if the input materials are reduced thrice then the overall production of any business will also be reduced by three times. Similarly there is another concept known as network effect which has nothing to with the production processing variable rather it deals with the marketing side. It says that if the production cost is high and the product which is produced is of good quality, still there are chances that the profit o industry will fail if there is not proper networking with the customer (Serrano & Boguná, 2003). There is another evolved version of new trade theory in the perspective of intra industry trade and that is known as “new” new trade theory.  P. Krugman (2007) was a pioneer in establishing a model for this theory. The example for the new trade theory and its relationship with the global markets can be apprehended from the fact that cars made my Ford are being used massively in Japan and similarly, cars made by leading manufacturers’ o Japan are being deployed in England or America. The trade process is no longer limited to the differences between certain demographical variables rather it has shifted it focus towards the nurturing effects of overall profits and return to scales. Rowthorn (1992) explained the relationship between intra industry trade and new trade theory very effectively. In traditional trade models, the nation’s resources were determined by currency and resources of the locality whereas the currency was based in gold and silver. The paper currency was not started at that time. In the 16th century, there was a theory called as mercantilism which argued that there should be a trade surplus. Trade surplus will help to determine the cost of the good produced locally. This surplus factor can be maximized by many ways. The exports can be increased through providing different subsidies as this will help the local market to flourish and gain strength whereas the imports should be minimized in order save the taxes. Different quotas and tariffs must be offered in order to reduce the imports. The imports are needed to be minimized in order to solve the problem of inflation. The intention was to maximize the local production in order to lower down the dependency cost. The imports are vulnerable to damage in case of any disaster or economic collapse of the source country. There were many flaws in this model and some of them are impaired growth and hindrances in trade. Increased tariffs will not allow the foreign investments to come in and that will be a major setback for the economy. In 1776, there was another theory and trade model based on the concept of absolute advantage, it said that a country should only produce those good in which it is more efficient and good at producing. But the same country should trade these good in those areas where the produced goods are not available or of bad quality. Contrary to the theory of absolute advantage, there was another model named as “theory of comparative advantage” which said that such kind of conditioned trade is not good for the new economies The concepts o free trade markets was introduced in which the country can produce those items on which it is not efficient as it will expand the exposure of the global markets and there will a competitive environment created. The general motors and Toyota are two top competitors in the automobile industry. They share the same target market, same standards for customer satisfaction and almost similar product line. Still how can these two companies compete with each other and what are the pivotal points that make the key differences for a customer and give them urge to choose only one of the two choices. The concepts of monopolists come in to play at this point. Monopolists have only two choices, if they want to invest; they have the best option to invest outside. If the demand is very low in the local markets then the monopolists can certainly export the products because it will give them more chances. Similarly, duty free sales are also a very important factor in the intra industry trade as it will be a direct consequence o increasing marketing size. The fact of the matter if that the intra industry trade gives more chances to flourish in the economic and cooperate sector as compared the conventional models because they are very limited in vision and scope. After the industrial revolution, there was an immense expansion in the companies in all the sectors and one country cannot limit its trades only to another country who have a high difference rates in terms of technology and geographies Conclusion: Both the new trade models and conventional trade models are dependent upon the scenario of the locality in which they are to be implemented. The emerging cooperate world is deploying the new trade policies very much because of their less hindrances and chance to flourish in free markets. References   Krugman, P. (2007). Does the new trade theory require a new trade policy?.The World Economy, 15(4), 423-442. Leamer, E. E., & Levinsohn, J. (1995). International trade theory: the evidence. Handbook of international economics, 3, 1339-1394. Mtigwe, B. (2006). Theoretical milestones in international business: The journey to international entrepreneurship theory. Journal of international entrepreneurship, 4(1), 5-25. Myint, H. (1958). The" classical theory" of international trade and the underdeveloped countries. The Economic Journal, 68(270), 317-337. Rowthorn, R. E. (1992). Centralisation, employment and wage dispersion.The Economic Journal, 506-523. Serrano, M. A., & Boguná, M. (2003). Topology of the world trade web.Physical Review E, 68(1), 015101 Read More