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This presentation is used in the Business Dynamics and System Modeling class taught by Pard Teekasap at Southern New Hampshire University
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Business Dynamics and System ModelingChapter 20: Commodity Cycles
Pard TeekasapSouthern New Hampshire University
Outline
1. Basic of commodity cycle2. Generic Commodity Market Model
Basic of commodity cycle
• Many industries experience chronic cyclical instability
• In these markets, the negative feedbacks through which price seeks to equilibrate supply and demand often involve long time delays, leading to oscillation
• Common explanation is that demand is cyclical. Yet many commodity markets fluctuate far more than the economy as a whole
Example of commodity cycle
10
100
1840 1860 1880 1900 1920 1940 1960 1980 2000
Pric
e,
Cu
(cen
ts/l
b)
Price
Trend
0.00
0.50
1.00
1.50
2.00
1920 1940 1960 1980 2000
US
Pro
du
cti
on
of
Cu
(mil
lio
n m
etr
ic t
on
s/y
ear)
USProduction
Trend
Trend Growth Rate = 1.7%/Year
0.50
1.00
1.50
2.00
1840 1860 1880 1900 1920 1940 1960 1980 2000
Pric
e,
Cu
(rati
o t
o t
ren
d)
0.20
0.60
1.00
1.40
1.80
1920 1940 1960 1980 2000
US
Pro
du
cti
on
, C
u(r
ati
o t
o t
ren
d)
Generic Commodity Market Model
Manufacturing supply chain and capacity utilization sectors
Production and Inventory
• Backlogs and other stages of processing and storage are omitted
Shipment Rate = Desired Shipment Rate * Order Fulfillment Ratio
Order Fulfillment Ratio = f(Maximum Shipment Rate/Desired Shipment Rate)
Maximum Shipment Rate = Inventory/Minimum Order Processing Time
Desired Shipment Rate = Customer Orders
Production and Inventory
• Production is modeled as a 3rd-order delayProduction Rate = DELAY3(Production Start Rate,
Manufacturing Cycle Time)Production Start Rate = Production Capacity *
Capacity Utilization
Capacity Utilization
• Utilization depends on producers’ expectations regarding the current profitability of operation.
• The impact of inventory adjustments on utilization is omitted
0.0
0.2
0.4
0.6
0.8
1.0
0.0 1.0 2.0 3.0 4.0
Expected Markup Ratio(dimensionless)
Ind
ica
ted
Ca
pa
cit
y U
tili
zati
on
(dim
en
sio
nle
ss
)
Capacity Utilization
Capacity Utilization = SMOOTH(Indicated Capacity Utilization, Utilization Adjustment Time)
Indicated Capacity Utilization = f(Expected Markup Ratio)
Expected Markup Ratio = Short-Run Expected Price/Expected Variable Costs
Short-Run Expected Price = SMOOTH(Price, Time to Adjust Short-Run Price Expectations)
Production Capacity
Production Capacity
Production Capacity = Capital Stock * Capital Productivity
Capital Stockt0 = (Reference Demand/Capacity Utilizationt0)/Capital Productivity
Discard Rate = Capital Stock/Average Life of Capacity
Acquisition Rate = DELAY3(Order Rate, Capacity Acquisition Delay)
Production Capacity
Capital on Ordert0 = Discard Rate * Capacity Acquisition Delay
Order Rate = MAX(0, Indicated Order Rate)Indicated Order Rate = Desired Acquisition Rate
+ Adjustment for Supply LineAdjustment for Supply Line = (Desired Supply
Line – Capital on Order)/Supply Line Adjustment Time
Production Capacity
Desired Supply Line = Expected Acquisition Delay * Desired Acquisition Rate
Expected Acquisition Delay = Capacity Acquisition Delay
Desired Acquisition Rate = Expected Discard Rate + Adjustment for Capacity
Adjustment for Capacity = (Desired Capacity - Capacity)/Capacity Adjustment Time
Expected Discard Rate = Discard Rate
Desired Capacity
Desired Capacity
• Based on a heuristic that producers keep investment if they believe new investment is profitable
Desired Capital = Capital * Effect of Expected Profit on Desired Capacity
Effect of Expected Profit on Desired Capacity = f(Expected Profitability of New Investment)
Expected Profitability of New Investment = (Expected Long-Run Price – Expected Production Costs)/Expected Long-Run Price
Effect of expected profitability on desired capacity
0.0
0.5
1.0
1.5
2.0
-1.0 -0.5 0.0 0.5 1.0
Expected Profitability of New Investment(dimensionless)
Eff
ec
t o
f E
xp
ec
ted
Pro
fit
on
De
sir
ed
Ca
pa
cit
y(d
ime
ns
ion
les
s)
Desired Capacity
Expected Long-Run Price = SMOOTH(Price, Time to Adjust Long-Run Price Expectations)
Expected Production Costs = SMOOTH(Unit Costs, Time to Adjust Expected Costs)
Unit Costs = Unit Variable Costs + Unit Fixed Costs
Demand
Price DemandCurveSlope
ReferenceIndustryDemandElasticity
IndicatedIndustryDemand
MaximumConsumption
+-
DemandAdjustment
Delay+
CustomerOrders
+
+
Other FactorsAffectingDemand
Demand
IndustryDemand
ReferenceIndustryDemand
ReferencePrice
Demand
Customer Orders = Industry Demand * Other Factors Affecting Demand
Industry Demand = SMOOTH(Indicated Industry Demand, Demand Adjustment Delay)
Indicated Industry Demand = MIN[Maximum Consumption, Reference Industry Demand * MAX(0,1 + Demand Curve Slope*((Price – Reference Price)/Reference Industry Demand))]
Demand
Demand Curve Slope = (-Reference Industry Demand * Reference Industry Demand Elasticity)/Reference Price
Price Setting
Price Setting
Price = Traders’ Expected Price * Effect of Inventory Coverage on Price * Effect of Costs on Price
Change in Traders’ Expected Price = (Indicated Price – Traders’ Expected Price)/Time to Adjust Traders’ Expected Price
Indicated Price = MAX(Price, Minimum Price)Minimum Price = Expected Variable Costs
Price Setting
Effect of Inventory Coverage on Price = f(Perceived Inventory Coverage/Reference Inventory Coverage)
• There are many possible functions, one example is
Effect of Inventory Coverage on Price = (Perceived Inventory Coverage/Reference Inventory Coverage)^Sensitivity of Price to Inventory Coverage
Price Setting
Perceived Inventory Coverage = SMOOTH(Inventory Coverage, Coverage Perception Time)
Inventory Coverage = Inventory/ShipmentsEffect of Costs on Price = 1 + Sensitivity of Price
to Costs * [(Expected Production Costs/Trader’s Expected Price) – 1]
