International Commodity

Management-Introduction

Anirban Kundu
 Commodity Taxonomy
• Commodities are classified into three categories:
Energy, Metals and Agriculturals

• The most basic divide among commodities is

between those that are storable, and those
• that are non-storable.
• Examples of non-storable commodity: electricity
(except hydro generation that is storable in some
electricity markets); weather.
• Storable commodities are heterogeneous:
• (1) continuous production and consumption,
absence of seasonal demand: industrial metal, e.g.
copper, aluminium
 Contd…
• (2) continuous production and consumption, with substantial
seasonal demand: Heating oil, natural gas, and gasoline

• (3) seasonality in production but relatively flexible in

production: Grains and oilseeds are produced seasonally, but
their production is relatively flexible because a major input –
land – is quite flexible; there is a possibility of growing corn on
a piece of land one year and soybeans the next year, and an
adverse natural event (such as a hail flood) may damage one
crop, but does not impair the future productivity of land.

• (4) seasonality in production but relatively inflexible in

production: In contrast, tree crops such as cocoa or coffee or
oranges are seasonally produced, but utilize specialized,
durable, and inflexible inputs (the trees) and damage to these
inputs can have consequences for productivity that last
beyond a single crop year.
 Why International Commodity Management?
• To stabilize trade, supplies, and prices of a commodity in the
world commodity market.
• Commodity prices strengthened in the first quarter of 2018. Broad-based
price increases were supported by both demand and supply factors.
Accelerating global growth lifted demand for commodities, while a
number of commodities faced supply constraints. For oil and precious
metals, concerns about mounting geopolitical risk also supported prices.
Crude oil prices are expected to average $65 per barrel (bbl) in 2018 (up
from $53/bbl in 2017) and remain at $65/bbl in 2019—an upward
revision from the October 2017 forecast. Metals prices are expected to
increase 9 percent in 2018 and, following three years of relative stability,
agricultural prices are expected to gain 2 percent in 2018. Looking
ahead, policy actions currently under discussion, such as additional
tariffs, production cuts, and sanctions, present risks to the short-term
outlook. This edition also analyzes the policies of oil exporting economies
in response to the 2014 oil price collapse. It concludes that oil exporters
with flexible currency regimes, larger fiscal buffers, and more diversified
economies fared better than others. The experience of the past four
years is a reminder of the urgent need for greater economic
diversification and stronger monetary and fiscal policy frameworks in oil
exporters (Executive Summary: Commodity Market Outlook, April
2018,World Bank )
 Areas need to be covered
• International Trade Theory
• International trade policy
• International Finance: Commodity spot and
derivative market, exchange rate, currency risk
• Fiscal policy, monetary policy-country specific
 International Trade Theory
• Adam Smith- Absolute (Cost) Advantage Theory

• David Ricardo- Comparative (Cost) Advantage

Theory

• Heckscher-Ohlin- Factor Endowment Theory

 Basic Questions in International Trade
Theory
• What determines the pattern of trade?

• Who gains from trade?

 Absolute Advantage Theory-Adam Smith
• Two country-two commodity framework
• Country A and Country B
• Both the countries producing two commodities X and Y respectively
• X and Y are produced only by using labour

Table 1: Absolute Advantage of Trade

Commodity
X Y
Labour Units
Country A 10 20
B 20 10

• Country A has absolute advantage in producing X and country B has

absolute advantage in producing Y
• If two countries were to exchange 2 goods @ 1:1 i.e. 1 unit of good X
for one unit of good Y,, country A could get a unit of good Y by using 10
units of labour to produce 1 unit of good X and trading that with B for
1 unit of good Y; whereas if A produced that unit of good Y itself then it
would have to give up 20 units of labour.
• 10 units of labour ‘saved’ can then be used to produce another unit of
X for home consumption.
Theory of Comparative Advantage: Ricardo
• What if one country is more productive than
other country in all lines of production?
• Comparative advantage and trade
• Ricardo on gains from trade
• Idea of opportunity cost
 Comparative Advantage
Labour cost of production (in hours)
1 unit of wine 1 unit of cloth
Labour Units
Country Portugal 80 90
England 120 100
Opportunity cost of production
1 unit of wine 1 unit of cloth
Labour Units
Country Portugal 80/90 = 0.89 90/80 = 1.1
England 120/100=1.2 100/120 =0.83
• Opportunity cost of wine is the amount of cloth that has to be
given up in order to produce an additional unit of wine.
• If it takes 120 hrs of labour in England to make 1unit of wine, while
it takes 100 hrs to make 1 unit of cloth, wine must be costly, wine
must be more expensive per unit than cloth- 1 unit of wine will
cost 120/100 or 1.2 units of cloth.
• If in Portugal it takes 80 hrs of labour to make 1 Unit of wine and
90 hrs to make 1 unit of cloth then cloth will be more expensive
than wine – 1 unit of wine will cost 80/90 or 0.89 units of cloth.
 Possibility of Trade
• If England could import 1 unit of wine at a cost
less than 1.2 units of cloth then she would gain
by doing so.
• If Portugal could import more than 0.89 units of
cloth in exchange for 1 unit of wine then she too
would gain.
• Therefore, if 1 unit of wine can be exported to
England from Portugal in exchange for something
between 1.2 and 0.89 units of cloth, both
countries will gain from trading.
 Comparative Advantage and Gains from Trade
• Production, Consumption and Trade
• The production possibility curve/frontier (PPC/ PPF)
• The quantity of each good a country produces will
depend on her factor endowments and on her
technical knowledge.
• Factor endowments: amount of factors of
production (labour, capital, land, any other natural
resources) the country possess.
• PPC is the boundary of all those combinations of
the two goods which the country can produce.
 Contd…
• Community Indifference Curve (CIC): CIC represents the
specific tastes and preferences of the community of a
country.

• Possibility of trading means that the country can produce

and consume at prices that differ from those prevailing in
isolation.

• Equilibrium condition under international trade Marginal

rate of transformation in production = International ToT
= Marginal rate of substitution in consumption

• Gains from trade: gain from exchange + gain from

specialization.
 Contd…
• Concept of Offer Curves: Locus of various
export-import combinations at changing ToTs
gives rise to a country’s offer curve.

• International ToT is determined by intersetion of

two countries’ offer curve
 Trade Policy
• Small country: Country cannot change the ToT
prevailing in the international market by
restricting trade (export-import)
• Large country: By restricting trade, country can
affect the international ToT.

• Restrictive trade practices:

• Import tariff in small country
• Export subsidy in small country
• Export tax in a small country
• Import quota in small country
• EU Common Agricultural Policy (CAP). Despite
reforms and some reduction in tariff rates, the EU
still impose substantial tariff rates on many
agricultural markets. The aim is to increase prices
for domestic European farmers in order to
increase their income.
• Some selected tariffs on EU agricultural products
including:
• For medium/ low-quality wheat, a duty of €12
per tonne. Barley, a tariff of €16 per tonne. Oats,
€89 per tonne, Beef tariff or ‘Hilton Quota’ The
EU’s current quota 37,800 tonnes – charged 20%
import duty. Above, the quota, the duty is much
higher: €2,700–€4,700 per tonne.
• Banana wars. For a long time, there were
substantial tariffs on banana imports from Latin
America. Exporters had to pay €176 (£141) per
tonne of bananas. But, in 2012, an agreement
has seen these tariffs reduced.
• Argentina food tariffs. Argentina has increased
imports duties on 100 products, including over a
dozen agricultural goods under the Mercosur
Common External Tariff (CET). In this example,
tariffs on the import of milk powder were
increased to 9% after record levels of imports
and fears Argentinian farmers would suffer
falling incomes.