Evan Soltas
Apr 6, 2012

Growing Pains

Does rising global income explain increasingly violent changes in commodity prices?

I have an idea which may explain the apparent increase in the severity of commodity price swings. Usually I don't post twice a day, but since I don't want to forget it, here it is in short:

Assume that real global income is increasing and over the long run will continue to do so at an exogenously-determined rate. Assume that this causes global aggregate demand to increase at an exogenously-determined rate in the long run, too, with random deviations over time. Assume that the price elasticity of demand for a given good or service is inversely proportional to the average fraction of income spent on that good or service -- in other words, consumers are relatively insensitive to price changes in cheap goods. Assume that the global aggregate supply curve and the microeconomic supply curves for specific goods and services do not change shape, and that they all shift outwards at a constant rate exogenous to our model -- i.e. the rate of long-run supply expansion is independent of aggregate demand. Therefore, as real incomes and aggregate demand increase, microeconomic price elasticities will fall for certain products where Engel's Law holds, because these products take up lesser percentages of income than before. All else equal, markets where the supply curve becomes sharply inelastic after a quantity Q is produced in the short run will tend to experience sharper price changes than they had before, when demand had been more inelastic because global real incomes had been lower.

Seems to me that this could work for gasoline and food in particular, given the rise in global income in the 2000s, which could explain not just price increases, but also the increase in price volatility for such goods. What do we think, commenters?