The determinants of the recent food price surges – A basic supply and demand model

This paper analyzes the factors behind the recent trends in food commodity prices, especially the question to what extent the price hikes are caused by fundamentals. Some of the main determinants have been identified and classified in ongoing studies. Based on this categorization, a basic supply and demand model for food commodity markets is developed in this paper that includes two arguments. One is that the growth rate of notional food demand differs from the growth rate of food supply. Consequently the prices have to adjust in order to restore an equilibrium situation in the food market. The second argument is the change in supply and demand elasticities causing swings in food prices. The model is applied for the prices of wheat and corn from 1990 to 2011 and compared with the actual spot prices. The results show that the model can replicate the prices of both food commodities up to 2006/2007 but a significant divergence appears thereafter. Financialization is identified as one reason for this development, but the demand from China and India is neglected as a reason behind price increases in many food commodities.