Commodity Definition

In its most traditional sense, a commodity is either a raw material or agricultural product which may be bought or sold on the commodity exchange, such as gold or cocoa. More recently, however, the definition has expanded to include financial products such as foreign currencies and indexes, which all now also belong to the commodity exchange – and, with the advent of technology, even mobile phone minutes and bandwidth!

A commodity usually has two basic properties:

1. it is usually produced and/or sold by many different companies. Commodities are fruits of the earth, meaning no one firm can patent or monopolise their sale and manufacture. Commodities industries are usually fairly competitive as a result.
2. it is uniform in quality between the companies that produce/sell it. A barrel of oil, for example, is the same regardless of the firm behind its manufacture. Companies selling commodities cannot compete on quality, unlike, say, the motor vehicle industry, where each product will have marked differences and unique features depending on the producer behind it (what economists call ‘product differentiation’).

How Are Commodities Bought And Sold?

The sale and purchase of commodities is usually carried out through futures contracts, which will stipulate a quantity and minimum quality standard of whatever commodity being traded. A contract for wheat, for example, might be signed by a trade board for 5,000 bushels of a particular industry-standard quality.

The price of a commodity, as with most assets, is subject to the fundamental economic laws of supply and demand. Although we might expect that commodities are sold for their marginal cost of production, in the real world the price is often higher, due to factors such as barriers to entry and firm-specific talents (perhaps one firm is more adept at growing healthy cocoa beans than another, for example).

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