Question

Draw a graph of the market for a primary commodity, such as cocoa beans, assuming that the demand is inelastic – think about what this means for the slope of the demand curve. Now think about supply – what happens to equilibrium when supply fluctuates from year to year because of the weather?   Now repeat the exercise for a processed good from the commodity, such as chocolate – this product does not have inelastic demand, so think about what this means for the slope of the demand curve. Shift the supply curve around to again see what happens to equilibrium and compare the price fluctuation between the two. What does this example demonstrate about developing country commodity exports for which demand is generally inelastic? What is the effect of processing a commodity such as cocoa beans into a product such as chocolate?

Answer 1

In case of inelastic demand, the demand curve has a higher slope, and in case of an elastic demand curve, the demand curve havs a lower slope. Consider the diagrams below -

The left panel is for the inelastic commodity and the right panel is for the elastic commodity. In both the cases, the supply curves shift to the left to a reduction in the supply of the commodities.

In the left panel, where the demand for the commodity is inelastic, the reduction in the supply causes the price to increase much more than the change in the quantity of the commodity. On the other hand, in the right panel, where the demand for the commodity is elastic, the reduction in the supply causes the quantity to decrease much more than the change in the price of the commodity.

This shows that the commodities that are inelastic such as those from the developing countries are more susceptible to supply shocks than the processed commodities of the developed countries.