Characteristics of the market economy, such as demand and supply, may be considered on their own, independently from each other only in a theoretical example. In terms of the real economy, they are interconnected through the price mechanism which in turn may have a number of provisions connected. The food crisis speaks true about the fundamental factors that were clearly responsible for keeping the price of cereals at $117 in 2000 and trade factors pushing the prices to $295 per metric ton in 2008. According to some commentators the spike in prices were also due to droughts in grain-producing nations and rising oil prices which in turn escalated the costs of fertilizers and food transportation.
First consider the situation: there is a product in the market to which the price is set at a level such that the portion of the product cannot be realized. In the graph shown below, it is a region lying above O point between the curves of supply and demand. In this case, the result of high prices is the formation of an excess of the product or available in oversupply. Such a state cannot exist for a long time, since an excess of goods leads to the need to reduce prices.
The following situation: obviously, the high price of goods as a result of competition will inevitably go down, because the price is unsustainable. However, if the price of the product falls too low, there will be a shortage, which will characterized by the excess of demand for the product. It is an area located below O point between the curves of supply and demand shown in the graph below. Now, competition between buyers will raise the price of the product. This price will be increased as long as the market does not have a situation when the quantity of goods which entrepreneurs are willing and able to produce and offer to the market, will be equal to the amount that consumers are willing and able to buy. As a result, there is no shortage or surplus of goods sold at a given price at which equilibrium occurs. The price appears, balancing between supply and demand, which called a market equilibrium price or market clearing price.
The establishment of the equilibrium price in a competitive market takes place under the influence of a change in trends in both demand and supply. The equilibrium market price is set as a cash equivalent to supply and demand. It’s equalized by the impact of the competitive market environment. Clarity, market equilibrium can be demonstrated with the help of the graph below.
Classical supply and demand graph
The demand curve d and the supply curve intersect at point O. The area which lies above O t has a surplus and region lying below O characterized by the deficit of the offered goods.
The ability of the competitive forces of supply and demand set the price level at which decisions on the sale and purchase are synchronized, called the balancing function of the prices. Changes in supply and demand to food products is most often associated with the price along with factors such as drought, slowing yield growth, low stocks, macroeconomics imbalances, rising oil prices and export restrictions. In a stable economy the prices at which goods are sold a lot, changed a bit slowly for a long time remaining unchanged. Prices may also change rapidly due to speculations.
There were 3 price shocks in the last 15 years in worldwide wheat market. The greatest growth of wheat price observed during 2007-2008 years.
2000-2015 price of wheat chart
During the 12 months from March 2007 to February 2008, wheat prices have doubled and exceeded 300 dollars per ton, setting a record in nominal terms. However, historical data show that in real terms the price of wheat may exceed even in normal times such as that happened in 1972 when the Soviet Union imported unexpected quantities due to the devastating result of agricultural policies.
The Burst of Bubble:
What happened in 2007? There was a combination of discretionary trade and the trade shocks.
1. Rice price started to rise in early 2007 much later than maize prices and just after the first rise in wheat prices.
2. Countries such as Thailand, India and Vietnam which account for sixty percent of global exports introduced restricts on their exports due to overshooting and rapid increases in domestic food prices.
3. These actions pushed the panic button triggering a huge import from the countries such as Philippines, Malaysia and Indonesia.
4. Philippines imported 1.3 mmt of rice in just the first four months of 2008 exceeding their entire import bill of 2007.
5. Malaysia and Indonesia announced they would double or triple government held stocks largely through increased imports.
6. To make the situation critical, India announced it will replace the ban with a minimum export price of $425 per ton which is still around $100 higher than comparable prices in Thailand export market.
7. Saudi import from Thailand rose by nearly 90% after India’s export ban and 2007 December the Saudis subsidize rice imports to the tune of $266 per metric ton.
8. Drought plus high inflation in Iran made it to import 0.8 million metric ton from Thailand.
9. Nigeria waived its 100 percent tariff on rice in early 2008 and procured 0.5 metric ton from Thailand.
10. Another cause for the rise is to be the diversion of food crops (maize) for making biofuels. An estimated 100 million tons of grain per year are being redirected from food to fuel.
The increase in demand contributes to the shift of demand curve to the right. Specifically, the amount required to market products of this type at each price level increased. If the market price will remain for some time at the former equilibrium level, there will be a deficit because the amount of the demand increase from q1 to q2, and the supply remains on the same level.
12. Demand shifts to the right
Resetting of price in 2008:
The panic buying from the countries came to a halt when there were enough indications that there is a record harvest and that supply was unlikely to be a constraint. Oil exporting too understood that prices could not last forever and were reluctant to buy at such inflated prices. The market was further calmed when Japan was permitted to re-export some of its rice stocks. In late May price declined further as trade restrictions eased, other commodities prices fell, and the dollar strengthened. Speculative hoarding that was at play gradually disappeared as speculators realized that prices could not continue to rise. The invisible hand that caused havoc slowly was allowed to take the back seat putting the price mechanism in the front place.
The global food crisis rejuvenated the concepts how trade shocks can be devastating despite having a strong economic fundamentals. The practice of discretionary trade still prevails in most of the so-called market economies always keeping the door open for speculations. In the words of President Clinton, the World Bank, IMF and US pressured Africans into dropping government subsidies for fertilizer and other farm inputs as a requirement to get aid making the continent food self-sufficient to food import continent.
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