Price Elasticity of Demand for Primary Commodities

In this short revision video we look at why the coefficient for many primary commodities is often low.

Why is the PED for many primary commodities often low?

Primary commodities include extracted products such as crude oil and natural gas together with food grown in farming sectors.

A low coefficient of PED means demand is price inelastic. For example, a 25% rise in crude oil prices leads to only a 5% fall in demand. PED = -0.2.

Many primary commodities have few close substitutes. Gas fired power stations must use gas, the commodity is a necessity.

In this case, energy generators must pay the going market price for the gas and – over time - look to find ways of improving efficiency.

The cost of switching to substitutes also helps explain low PED. Food processing companies for example will have a low PED in the short run.

Their manufacturing processes are geared to using specific ingredients and they may be able to pass on higher costs to buyers.

Evaluation points

• PED can be expected to increase the longer the time frame we allow for buyers of primary commodities to adjust to price rises
• A recent example is the sharp increase in natural gas prices during 2022 following Russia’s invasion of Ukraine. This has prompted many countries to attempt to switch away from gas, pushing up demand for more price competitive options, including coal. There has also been increased investment into renewable energy capacity.
• Over time, if the prices of primary commodities stay high, there is an incentive for innovation to find alternative sources. For example, car and smartphone battery manufacturers are looking to reduce their dependence on the primary commodity lithium whose global price has surged in recent years.