Question 1: (23 marks total)
a. Plot world wheat prices from Jan 2015 to July 2022. (1)
b. On the same graph, plot inflation rates over the same period and on the secondary axis
(view example on the excel file). (1)
c. What is the relationship between the two? Run a regression to show the relationship
statistically, wheat prices as the independent variable and inflation as the dependent
variable. (2)
d. State the month when inflation really begins to take off (increase)? (1)
e. Now re-run the regression in two parts, first for the period from Jan 2015 to Dec 2020;
second from Jan 2021 to July 2022. Explain your results. (3)
Background Information:
Use Canada as an example of a wheat producer/exporter. Note that the production of
wheat each year requires farmers to decide in March-April which crops they will grow. If
they wish to produce more wheat, they will allocate more of their land to wheat and
away from the alternative crop they would otherwise be growing (e.g., canola). In
anticipating their wheat production, they will have to acquire adequate supplies of
fertilizer and other farm inputs, typically making purchases also in those early spring
months. The wheat price will be determined by the world supply and demand. Some
supplies of wheat will be determined even earlier if there is planting of winter wheat or
an earlier growing season.
f. Describe the process by which inflation will affect Canadian wheat prices. (3)
More information:
Suppose inflation in wheat producing countries starts to rise in (Canadian data follows)
July 2021, jumping from 3.1 to 3.7%, and only begins to rise seriously in Jan 2022
(monthly inflation hits 5%), rising each month to June (8.1%). By planting decision time,
inflation is running at annual rate of 5-7% (year over year, calculated each month.
g. How will that affect wheat prices over the period from January to July 2022 that we
have so far observed? Putting this differently, if there was no significant inflation in
2021 through to date, how would this have changed the observed rise in global wheat
prices? (3)
h. How would the actual observed inflation affect world wheat prices looking forward (in
the future), ignoring other factors in the wheat market such as the war in Ukraine? (2)
i. Assume that fertilizer input costs account for 30% of total revenues. If fertilizer costs
doubled, and if wheat prices increased by 50%, we wish to calculate the net effect on
profits and planting decisions (these are roughly realistic numbers for spring 2022).
i. Calculate the effect on net profit or earnings before taxes for “Wheat-Hard
Red Spring” (The relevant financial data can be found on Page 4 of the
following document: https://www.gov.mb.ca/agriculture/farmmanagement/production-economics/pubs/cop-crop-production.pdf) (3)
ii. What is the effect on farmer’s planting decision from this change in profit?
i.e., will they increase wheat plantings, given both an increase in fertilizer
costs and an increase in the wheat price? (2)
j. Now show how this example of the long term effect of inflation will likely affect wheat
prices (for late 2022, 2023)? (2)
Question 2: (9 marks total)
a. Plot the relationship between agricultural commodity prices (Farm Product Price Index)
& retail food prices (Food CPI). Do this for Jan 2020 through to July 2022. (1)
i. What is the relationship between the two? (1)
b. Conduct regressions and interpret the corresponding R Squared values
i. Food CPI in period t-1 (Independent variable) on Farm Product Price Index in
period t (Dependent variable). (2)
ii. Farm Product Price Index in period t-1 (Independent variable) on Food CPI in
period t (Dependent variable). (2)
iii. Contemporaneous effects, Farm Product Price Index in period t
(Independent variable) on Food CPI in period t (Dependent variable). (1)
c. Give some economic arguments for why one direction of causation would be more
plausible than another (comparing i. with ii.)?
Sample Solution
