bdsm-ch20 commodity cycles

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Business Dynamics and System Modeling Chapter 20: Commodity Cycles Pard Teekasap Southern New Hampshire University

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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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Page 1: BDSM-CH20 Commodity Cycles

Business Dynamics and System ModelingChapter 20: Commodity Cycles

Pard TeekasapSouthern New Hampshire University

Page 2: BDSM-CH20 Commodity Cycles

Outline

1. Basic of commodity cycle2. Generic Commodity Market Model

Page 3: BDSM-CH20 Commodity Cycles

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

Page 4: BDSM-CH20 Commodity Cycles

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)

Page 5: BDSM-CH20 Commodity Cycles

Generic Commodity Market Model

Page 6: BDSM-CH20 Commodity Cycles

Manufacturing supply chain and capacity utilization sectors

Page 7: BDSM-CH20 Commodity Cycles

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

Page 8: BDSM-CH20 Commodity Cycles

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

Page 9: BDSM-CH20 Commodity Cycles

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

)

Page 10: BDSM-CH20 Commodity Cycles

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)

Page 11: BDSM-CH20 Commodity Cycles

Production Capacity

Page 12: BDSM-CH20 Commodity Cycles

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)

Page 13: BDSM-CH20 Commodity Cycles

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

Page 14: BDSM-CH20 Commodity Cycles

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

Page 15: BDSM-CH20 Commodity Cycles

Desired Capacity

Page 16: BDSM-CH20 Commodity Cycles

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

Page 17: BDSM-CH20 Commodity Cycles

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)

Page 18: BDSM-CH20 Commodity Cycles

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

Page 19: BDSM-CH20 Commodity Cycles

Demand

Price DemandCurveSlope

ReferenceIndustryDemandElasticity

IndicatedIndustryDemand

MaximumConsumption

+-

DemandAdjustment

Delay+

CustomerOrders

+

+

Other FactorsAffectingDemand

Demand

IndustryDemand

ReferenceIndustryDemand

ReferencePrice

Page 20: BDSM-CH20 Commodity Cycles

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))]

Page 21: BDSM-CH20 Commodity Cycles

Demand

Demand Curve Slope = (-Reference Industry Demand * Reference Industry Demand Elasticity)/Reference Price

Page 22: BDSM-CH20 Commodity Cycles

Price Setting

Page 23: BDSM-CH20 Commodity Cycles

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

Page 24: BDSM-CH20 Commodity Cycles

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

Page 25: BDSM-CH20 Commodity Cycles

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]