Appendix I Commodity Support Prices and Price Volatility
There have been two main issues concerning the impact of support prices. The first has been that by leading to an excessive increase in production they have led to a decline in the world commodity prices, which in turn has had an adverse effect on the foreign exchange earnings of developing countries exporting these commodities. The second issue has been that support prices have led to an excessive volatility in many of the world commodity markets. These two issues can be examined analytically in terms of a wedge which is driven between prices faced by the producers and consumers of the commodity. The following model can clarify the two propositions:
Suppose that the demand for the commodity depends on its current world price Pt:
But the supply depends on the support price
Since the support price will be significant only if it is greater than the market price, It is reasonable to assume that
Suppose that each year’s supply is sold, i.e.,
Then using (10) the equilibrium price Pe would be given by substituting
If we assume that b1 > 0 (the supply curve slopes up) and also a1 > 0 (the demand curve slopes down), (12) indicates that the world equilibrium price would be lower compared to a case where there was no support price (i.e., δ=1).
Suppose next we want to examine the time path of prices, starting at P-Pq. For this we take the first-order linear difference equation (11a) and find its solution which indicates the price in period t as a function of the price in period 0. The solution is
suppose that P0 > Pe, then the price will converge on Pe only if
as t∞ i.e., if elasticity of supply is less than that of demand. This is a
standard result. However,
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The author is grateful to Roger Pownall with whom the analytical approach developed in the paper was discussed at length, and to Mohsin Khari, Peter Wickham, and Blair Rourke for helpful advice and comments. Toh Kuan provided excellent research assistance.
The above, of course, does not imply that commodities are perfectly homogenous in an absolute sense. For many commodities, there can be significant differences in the quality and other characteristics which reduce the degree of substitutability amongst different units of the same commodity. See, for instance, Radetzki (1990). (This is one of the reasons for using the “imperfect substitutes” framework in the econometric analysis undertaken in Section IV below). However, it is generally the case that in relative terms commodities are more homogenous than manufactured goods.
These data are obtained from the UNCTAD yearbooks, supplemented, or cross-checked, with data from the World Bank’s TARS Databank. At the time of writing, 1987 was the last year for which detailed data were available.
These data are derived from United Nations (1990) which provides data on world non-fuel commodity exports and world merchandise exports. The subgroups of commodities corresponds to the categories used by the International Monetary Fund. See IMF (1990).
For detailed analysis, see IMF (op.cit).
The coverage of industrial and developing countries corresponds to the coverage in the International Financial Statistics.
For industrial countries the share declined from 25 percent to 19 percent, while for developing countries it declined from 68 to 49 percent.
According to the UNCTAD data, total industrial country exports in 1978 amounted to $854.4 billion whilst developing countries’ amounted to $445.8 billion. By 1987 exports had increased to $1710.7 and $783.3 billion for the two groups respectively. See UNCTAD (1990) Table 1.
A recent study by Redetzski (1990) supports the finding of this paper. According to this view, it is primarily the diversification of developing country commodity exports which has led to a decline in their share of world commodity exports.
See, for instance, Redetzski (1990).
For a detailed discussion of this, see Rosenblatt et al (1988). For a discussion of the implications of support prices for price volatility, see Appendix.
Detailed information on the evolution of these shares over the period 1965 to 1985 is available from the author, the last year for which detailed data were available at the time of writing
This is based on U.S. and EC’s share of 55.5 relative to the total of 70.1.
There is a voluminous literature in this area. For a recent summary, see Radetzski.
For certain agricultural commodities, it might appear more appropriate to use a longer lag structure than the one year lag employed here. A preliminary analysis using two and three year lags did not, however, lead to any significant changes in the results reported below.
It is important to note that given the differing composition of commodity groups across different regions, their export prices will also differ.
It should be noted that since a simultaneous-equation technique is used for estimation, the choice of equation to be normalized would not have a bearing on the results.
As noted earlier, given the significant differences in quality, the average world price for any commodity group can differ markedly for the price of a commodity group from a given region.