© Tutor2u Limited All Rights Reserved. These study notes are protected by copyright and may not be reproduced in part or in whole, for whatever reason, without the prior written permission of tutor2u. The use of tutor2u content for commercial gain of any kind is strictly forbidden. We reserve the right to take legal action against any party or parties found to have breached our copyright.

AS Markets & Market Systems

Price Volatility in Markets

We often find that prices in markets rise and fall by large amounts over a short time period. They display a high level of volatility which directly affects both consumers and producers. In this chapter we look at some of the reasons for fluctuating prices and consider some real-world examples.

Price stability

Not all markets experience volatile prices. They tend to be markets with products where the conditions of supply and demand are relatively stable from year to year and where the elasticity of demand and the elasticity of supply are both high. We can see this in the diagram below.

The price of milk is pretty stable over time.  Partly this is due to intense competition between the leading supermarkets but the conditions of market demand and supply are also relatively stable and predictable.

Price volatility

Products with unstable conditions of supply and demand will experience price fluctuations from year to year. For example, for many products there are large seasonal variations in market demand which cause prices to rise sharply at peak times and then fall back during the off-peak periods. Seasonal demand is particularly strong in the tourism and leisure industries. The cost of hotel rooms and the prices of package holidays are always higher during the school holidays because hoteliers and travel businesses know that, at times of peak demand, the demand for holidays is price inelastic and that families will have to pay higher prices because they are limited to when they can take their holidays.

Agricultural prices and prices of other traded commodities

Agricultural prices tend to be volatile (unstable) because:
Supply changes from one time period to the next because of variable weather conditions which affect the size of the harvest

• When actual output falls short of planned output, for a given level of demand, price will rise
• When actual output is in excess of planned output, for a given level of demand, market price will fall

The effects of changes in supply can be amplified by a price-inelastic demand, for example in markets for raw materials and components where the buyer regards them as essential to their production processes, they must buy at whatever the prevailing market price is.

Price volatility can be magnified because of the activity of speculators in markets who are betting on future price changes. We have noticed this in many of the world’s commodity markets during the recent boom in international commodity prices. Hedge funds and pension funds together with other speculators have been buying into “hard commodities” such as copper, nickel, tin and also “softs” such as rubber and coffee because they expect market prices to remain high. Their demand has the effect of driving prices higher at times when stocks of these commodities are low.

Example of price volatility – the market for nickel

In July 2006 nickel prices climbed to a record high capping a near 50 per cent rise in less than a month and a 90 per cent rise within the space of nine months!. The price increases were down to two fundamental market forces - demand is strong but stocks or inventories of the metal are low. If there isn’t enough nickel in the market, the price can only head in one direction!

By the middle of July, stockpiles of Nickel held at London Metal Exchange registered warehouses were the equivalent to just two days’ worth of demand. Only about 1.3 million tonnes of Nickel is produced each year. But industrial demand from countries such as China has been rising strongly, especially because many industrial users are demanding nickel for stainless steel production having switched from alternative metals such as manganese. China has been responsible for nearly half the increase in global demand for nickel this year.