Primary product dependency (PPD)

Define the term 'primary product dependency (PPD)'

When developing and emerging economies depend on exporting raw materials or commodities

Give examples of primary products

• Coal

• Iron ore

• Vanilla extract

• Copper

• Gas

Why is the PED for primary products inelastic?

Primary products are often necessities with few substitutes and so consumers will continue to purchase them even if the price increases.

Why is the PES for primary products inelastic?

Primary products such as vanilla beans take a long time period to grow or hard commodities such as copper & gold to mine from the ground. As a result, even if producers want to increase supply in respond to a increase in price, they cant suddenly produce more due to the time lag faced within the production process.

Also, primary products are difficult to store as they are highly perishable meaning that producers cant easily keep them as excess stock and then quickly expand supply when price increases as they may detoriate.

Why is the demand for primary products income inelastic?

Primary products are often necessities with few substitutes and so consumers will continue to purchase despite changes in income.

Define the term 'price instability'

When small changes to supply & demand lead to sharp changes in price.

Give three examples of price instability, using a country of your choice

• In Chile, the 2010 Pichilemu earthquake impacted many vineyards around the coast of Chile with grapes falling off. This caused the supply of grapes to decrease, leading to a sharp increase in price. This led to price instability

• In Chile, its sunny weather in 2011 produced a substantially good harvest of grapes. This means that chilean vineyards had more grapes than usual to sell. his caused the supply of grapes to increase, leading to a sharp fall in price. This led to price instability.

• In northern Chile, copper mines were producing $Billions of copper anually. In 2008, following the global reccesion fewer producers were purchasing copper due to sharp falls in business confidence as they had less incentive to invest into capital equipment. This caused the demand for copper to decrease, leading to a sharp 50% fall in the price of copper. This led to price instability.

What is the impact of price instability on economic development?

Price instability often leads to lower levels of FDI. → Difficult for foreign investors to predict revenues and profits, → Harder to determine whether the investment is lucrative. → Rather than taking risk they simply wont invest in PPD economies → Given that investment (I) is a component of AD = C+I+G+(X-M), AD decreases → Increase in deflationary pressures → Real GDP falls → Unemployment rises → GNI/Capita falls → Living standards fall → Development worsens.

Also, Productivity falls → LRAS falls → Cost of producing one unit rises → Increase in inflationary pressures → Less internationally price competitive → Export demand falls → Export revenue falls → Less corporation tax revenue → Less funds for development, worsening development.

How can PPD lead to export led growth

Copper makes up 73% OF zambias share of exports. → Allows them to export a large proportion of output to foreign markets such as china and Switzerland. → export revenue rises → Improves the (X-M) component of AD = C+I+G+(X-M), increasing AD. → Increase in inflationary pressures → Real GDP rises → Unemployment falls → GNI/Capita rises → Living standards rises → Development improves.

How can PPD lead to higher levels of FDI?

Abundant natural recourses and profitable extraction opportunities attract foreign investors. → Given that investment (I) is a component of AD = C+I+G+(X-M), AD increases → Increase in inflationary pressures → Real GDP rises → Unemployment falls → GNI/Captia rises → Living standards rise → Development improves .

Also, Productivity rises → LRAS increases → Cost of producing one unit falls → Increase in deflationary pressures → More internationally price competitive → Export demand falls → Export revenue rise → More corporation tax revenue → More funds for development, improving development.

How can PPD lead to higher levels of tax revenue ? (Inelastic demand argument)

The demand for primary products does not respond proportionately to change in price as they are often necessities with few substitutes and so consumers will continue to purchase them even if the price increases, suggesting inelastic demand (Diagram). Total export revenues increase, as illustrated by the area of revenue gain. As revenues and profits rise, the governemnt is able to collect more corporation tax. As a result, tax revenues rise meaning there is more funds available to spend on development schemes such as healthcare, education or pensions. Therefore, economic development improves.

How are PPD countries susceptable to exogenous shocks?

They rely heavily on a narrow range of exports that take up a large proportion of GDP. → In northern Chile, copper mines were producing $Billions of copper annually → In 2008, following the global recession fewer producers were purchasing copper due to sharp falls in business confidence → Demand for copper fell . → Both the PED and PES of primary products are relatively inelastic in the short run → Fall in export demand led to a sharp 50% fall in the price of copper → This decreases the (X-M) component of AD = C+I+G+(X-M), decreasing AD. → Increase in deflationary pressure → Real GDP falls → Unemployment rises → GNI/Capita falls → Living standards fall → Development worsens.

Explain the Prebisch-Singer hypothesis

As world income rises, the demand for primary products will only increase marginally, whilst there will be an increase in demand for manufacturing goods becuase of their divergences in YED. This means that the price of manufactured products will increase much more than the price of primary products. Countries who import manufactured goods and export primary products may experience a detoriation in the terms of trade as the index of import prices exceed export prices.

What is the formula for the terms of trade?

TOT = (Index of export prices/Index of import prices) x 100

Explain the impact of the terms of trade detoriating

As their terms of trade deteriorates, the money they earn from their primary product exports will be able to buy fewer imported capital goods.

Given that investment (I) is a component of AD = C+I+G+(X-M), AD decreases → Increase in deflationary pressure → Real GDP falls → Unemployment rises → GNI/Capita falls → Living standards fall → Development worsens.

Also, Productivity falls → LRAS falls → Cost of producing one unit rises → Increase in inflationary pressures → Less internationally price competitive → Export demand falls → Export revenue falls → Less corporation tax revenue → Less funds for development, worsening development.

Define the term 'buffer stock'

A scheme where the government buys and sells primary products in order to reduce price volatility

(13) Draw a buffer stock diagram and explain what happens when there is high supply

• A price floor (Pfloor) and price ceiling (Pceiling) is enacted by the government in order to stabilise prices of volatile goods in a target range.

• In a good harvest, there is high supply but this will lead to a price below Pfloor which is at P2.

• As this is below the permitted fluctuations, the government purchases the surplus, represented by the difference between quanitity demanded and supplied at Pfloor (Q2-QD) in order to contract market supply and to bring the price back to the average P1.

• This means that there are fewer goods in the market, causing market supply to contract and raises the equilibrium price closer to the average price P1.

• The goods purchased will go into the buffer stock and so, the number of goods in the buffer stock will increase.

Draw a buffer stock diagram and explain what happens when there is low supply

• A price floor (Pfloor) and price ceiling (Pceiling) is enacted by the government in order to stabilise prices of volatile goods in a target range.

• In a bad harvest, there is low supply but this will lead to a price below Pceiling which is at P3.

• As this is above the permitted fluctuations, the government releases the stored stock, represented by the difference between quanitity demanded and supplied at Pceiling (C-Q3) in order to contract market supply and to bring the price back to the average P1.

• This means that there are more goods in the market, causing market supply to expand and lowers the equilibrium price closer to the average price P1.

• The goods will exit the buffer stock and so the number of goods in the buffer stock will decrease.

Give an example of a buffer stock scheme

India's FCI, buys rice at minimum support price (MSP) stored as part of a buffer stock for wheat. Stocks are released when prices rise or during shortages. In 2023 and 2024 Indias FCI released over 50mn tonnes of rice reserves.

What are the advantages of a buffer stock scheme?

Promotes investor confidence. Stable prices make it easier for foreign investord to predict future revenue and profits, allowing for a clear assessment on whether the investment into PPD economies is lucrative. This leads to greater incentives to invest, increasing FDI inflows.

Food security. Buffer stocks ensure adequate supply of essential commodities during poor harvests or external shocks. This allows shortages to be avoided and for prices to remain affordable. Households can continue to afford life sustaining goods and services, leading to a fall in malnutrition and food insecurity. As a result, life expectancy may improve which inflates the value of the HDI indicating economic development.

What are the disadvantages of a buffer stock scheme?

There is an opportunity cost accosiated with buffer stocks. They may not lead to growth and development as firms have an incentive to overproduce because the government has garunteed to buy any excess stock. As a result, it quickly becomes expensive to run which arises to an opportunity cost for the governemment as they forgoned the next best alternative of allocating its funds towards development projects such as improvements in healthcare, education and pensions. Therefore, this may erode life expectancy and literacy rates which deflates the value of the HDI indicating poor levels of economic development.

It depends on the type of primary product. Durable goods such as grains can be stored relatively easily, whereas highly perishable goods such as grapes may detoriate before they can be released onto the market.

Define industrialisation

An attempt to stop counties from producing primary products but instead manufactured goods in an attempt to improve terms of trade.

Explain the Lewis Model and its impact on growth and development

There might be only one manufacturing firm in a developing country. Because that firm is the only employer, they are described as a monopsony market structure → Can set very low wages as workers have no choice but to work for them → Higher supernormal profits → greater source of internal finance → Reinvest their supernormal profits back into operations by engaging in investment in R&D and Machinery to increase output. → Demand for labour increases since it is derived from the demand for goods and services → Wages rise → Workers that are already employed in the agricultural sector will be attracted to jobs in the industrial sector →This would continue until a large proportion of the population would have jobs in the manufacturing sector.

Evaluation of Industrialisation

Transfer Pricing may occur which is where a firm in one country might sell the product to the same firm in a different country for a very low or high price. → This doesn’t impact the overall firms profits but it means that they can declare all of their profit in whichever country has the lowest rate of corporation tax → The Global Financial Integrity research group estimated that in 2025 Trillions of tax are lost each year through transfer pricing. → This would constrain the government’s tax revenue, limiting the extent in which spending occurs on growth and development