Example 6 Declining Demand And The Behavior tf V r i Of Copper Prices

After reaching a level of about $1.00 per pound in 1980, the price of copper fell sharply to about 60 cents per pound in 1986. In real (inflation-adjusted) terms, this price was even lower than during the Great Depression 50 years earlier. Only in 1988-1989 did prices recover somewhat, as a result of strikes by miners in Peru and Canada that disrupted supplies. Figure 2.18 shows the behavior of copper prices in 1965-1993 in both real and nominal terms.

The world-wide recessions of 1980 and 1982 contributed to the decline of copper prices; as mentioned above, the income elasticity of copper demand is about 1.3. But copper demand did not pick up as the industrial economies re-

FIGURE 2.18 Copper Prices 1965-1993. Copper prices are shown in both nominal (no adjustment for inflation) and real (inflation-adjusted) terms. In real terms copper prices declined steeply from the early 1970s through the mid-1980s as demand fell. In 1988-1990 copper prices rose in response to supply disruptions caused by strikes in Peru and Canada, but prices later fell after the strikes ended.

FIGURE 2.18 Copper Prices 1965-1993. Copper prices are shown in both nominal (no adjustment for inflation) and real (inflation-adjusted) terms. In real terms copper prices declined steeply from the early 1970s through the mid-1980s as demand fell. In 1988-1990 copper prices rose in response to supply disruptions caused by strikes in Peru and Canada, but prices later fell after the strikes ended.

covered during the mid-1980s. Instead, the 1980s saw the beginning of a deep decline in the demand for copper.

This decline occurred for two reasons. First, a large part of copper consumption is for the construction of equipment for electric power generation and transmission. But by the late 1970s, the growth rate of electric power generation had fallen dramatically in most industrialized countries. (For example, in the United States the growth rate fell from over 6 percent per annum in the 1960s and early 1970s fro less than 2 percent in the late 1970s and 1980s.) This meant a big drop in what had been a major source of copper demand. Second, in the 1980s other materials, such as aluminum and fiber optics, were increasingly substituted for copper.

Copper producers are concerned about the possible effects of further declines in demand, particularly as strikes end and supplies increase. Declining demand will depress prices; to find out how much, we can use the linear supply and demand curves that we just derived. Let us calculate the effect on price of a 20 percent decline in demand. Since we are not concerned here with the effects of GNP growth, we can leave the income term/lout of demand.

We want to shift the demand curve to the left by 20 percent. In other words, we want the quantity demanded to be 80 percent of what it would be otherwise for every value of price. For our linear demand curve, we simply multiply the right-hand side by 0.8:

Supply is again Q = -4.5 + 16P. Now we can equate supply and demand and solve for price:

or P - 15.3/22.4 = 68.3 cents per pound. A decline in demand of 20 percent therefore implies a drop in price of roughly 7 cents per pound, or 10 percent.

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