FRE 306 (2023): Assignment #1
SOLUTION
Section A. Calculate and provide in the space provided. (5 marks)
1. Suppose you were given the following price series in nominal (observed) terms and the CPI
(Consumer Price Index) series. Calculate the real price series using 2020 as the base year.
Formula: Real Price = Nominal Price / CPI then adjust for the base year by multiplying by CPI in
the base year. RP = (NP/CPI) x CPIbase year
NOTE: 2020 CPI info was not given in the question. Therefore, students may either use 165 (as
was given in Lec 2 slide 3) or they can look it up. For example, Statcan says Annual AVG CPI for
2020 was 137.0, for example. (Source: HERE). Either is acceptable
Year
Nominal Price CPI
Real Price (2020 dollars)
(2020 CPI of 165)
(CPI of 137)
a. 1989
0.30
74.8
___0.66
0.55
b. 1994
0.39
85.7
___0.75
0.62
c. 1999
0.45
92.9
___0.80
0.66
d. 2004
0.51
104.7
___0.80
0.67
e. 2010
0.54
114.4
___0.78
0.65
Section B. Fill in the blanks with the appropriate number or terms. (6 marks)
1. Assume the demand for wheat has an income elasticity of greater than 1 in China. If Chinese
incomes increase by 10 percent, this will increase the quantity of wheat demanded in China by
__more than 10_______ percent.
2. Crop prices should continually rise between harvests to account for __storage__ costs.
3. The act of profiting from price differences across regions or time periods is referred to as
__arbitrage__.
4. Lower food inventory levels with constant demand creates __increased (or upward)___
pressure on food prices.
5. Stock-to-use ratios and global food prices are generally __negatively___ related.
6. Corn and soybean prices are correlated because they are often considered ___substitutes___
for farmers.
Section C: True / False / Uncertain (TFU) questions. (5 marks each; total 20 marks).
Indicate whether you judge the following statements to be True, False, or Uncertain. In each case
explain and defend your answer in several sentences, using supply and demand diagrams when
appropriate. This explanation will determine your grade for the question.
1. TFU: The agricultural commodity, wheat, is one of the products typically used to calculate the
CPI.
False. Wheat as a commodity is not a retail food. It is what would be called an
intermediate food. Therefore it is not included in the CPI which includes only
consumer goods, sold at retail. Bread would be in the CPI but not a raw material
such as wheat.
2. TFU: A food product such as bread or flour might see an increase in real price despite a fall in
the real price of wheat in global markets.
True. There are many other inputs and costs that contribute to the price of bread and flour aside
from wheat. Even if the real price of wheat is falling over time, the other costs involved in
producing bread or flour, such as labour and energy, may be rising in real terms, offsetting the
fallen price of wheat so that the bread or flour prices are rising in real terms.
3. TFU: Agricultural price cycles and declining real trend prices cannot be observed together.
False. The trend price path is a long run situation, with the possibility that in the short run prices
may rise and fall in some random fashion, or rise and fall in a more systematic fashion as in a
cycle. So the two observations are quite consistent, with the trend being a long run situation,
usually considered to be longer than 10 years, and the cycles being a short run observation,
usually for periods of less than 10 years, or shorter.
4. TFU: Research in technology and adoption by farmers of technology causes inflation of food
prices.
False. Generally, research in technology results in improvements of crop yields, more efficient
farming practices, more mechanization, and high rates of return (over 40 – 60 percent or more;
lowest estimate is 20% return). This results in farmers becoming more efficient often decreasing
input costs, and therefore not putting inflationary pressure on food prices.
Slower investment in agricultural research could cause food inflation; more investment in ag
research generally does not cause food inflation.
Section D: Price Trends (6 marks each; total 12 marks)
1. Using a supply and demand curve diagram with a brief explanation, show the underlying cause
for the trend of long-term decline in real prices of agricultural commodities.
Over time there has been a gradual and relatively modest shift to the right in the demand curve
for food (due to population growth, for example), but there has also been much more dramatic
shifts to the right in the supply curves of many commodities (due to improvements in yield and
other elements of technical change,for example). This will produce a declining price over time,
when supply shifts to the right are greater than small demand shifts to the right.
2. Using a supply and demand curve diagram with an explanation, show the underlying cause for
the recent trend of increasing food prices.
There has been a recent trend of increasing food prices. This is due to many factors, primarily
being an increase of production costs (higher energy costs, labour costs, etc.). Increased costs
of production will shift the supply curve to the left (i.e. decreasing supply). Furthermore, the
war in Ukraine and unfavourable weather (in certain regions) can also be attributed to a
reduction of supply. With the supply curve shifting up (and to the left), and we assume demand
remains the same, results in increased prices.