OCR2888: Understanding Food Price Volatility

The Lex column in today’s Financial Times has a superb piece on why food prices may start rising again raising fresh fears of high food price inflation. The key is to understand the reactions of farmers to changes in prices and the decisions they make about whether to plant new crops on marginally productive land. See this short extract:

“The cost of corn, soya and wheat has fallen sharply from the levels they reached last summer at the height of the commodity boom. But lower prices mean lower returns per acre, so farmers are cutting plantings of marginally productive land to maximise profits…....This is precisely the set-up investors who worry about a rapid return of inflation fear: low prices lead to underinvestment and cuts in productive capacity. When the economy picks up, prices soar because suppliers – in this case, farms – cannot keep up with renewed demand.”

(1) How could you illustrate the process described above with supply and demand diagrams?

(2) Explain why price elasticity of demand and price elasticity of supply is relevant in explaining food price volatility

(3) What do you understand by the term ‘marginally productive land’?

The rest of the LEX column can be found here

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