bdsm-ch20 commodity cycles
DESCRIPTION
This presentation is used in the Business Dynamics and System Modeling class taught by Pard Teekasap at Southern New Hampshire UniversityTRANSCRIPT
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]