What Is a Commodity in Economics?

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In economics, a commodity is defined as a tangible good that can be bought and sold or exchanged for products of similar value. Natural resources such as oil as well as basic foods like corn are two common types of commodities. Like other classes of assets such as stocks, commodities have value and can be traded on open markets. And like other assets, commodities can fluctuate in price according to supply and demand.

Properties

In terms of economics, a commodity possesses the following two properties.  First, it is a good that is usually produced and/or sold by many different companies or manufacturers. Second, it is uniform in quality between companies that produce and sell it. One cannot tell the difference between one firm's goods and another. This uniformity is referred to as fungibility. 

Raw materials such as coal, gold, zinc are all examples of commodities that are produced and graded according to uniform industry standards, making them easy to trade. Levi's jeans would not be considered a commodity, however. Clothing, while something everyone uses, is considered a finished product, not a base material. Economists call this product differentiation.

Not all raw materials are considered commodities. Natural gas is too expensive to ship worldwide, unlike oil, making it difficult to set prices globally. Instead, it is usually traded on a regional basis. Diamonds are another example; they vary too widely in quality to achieve the volumes of scale necessary to sell them as graded commodities. 

What is considered a commodity can also change over time, too. Onions were traded on commodities markets in the United States until 1955, when Vince Kosuga, a New York farmer, and Sam Siegel, his business partner tried to corner the market. The result? Kosuga and Siegel flooded the market, made millions, and consumers and producers were outraged. Congress outlawed the trading of onion futures in 1958 with the Onion Futures Act. 

Trading and Markets

Like stocks and bonds, commodities are traded on open markets. In the U.S., much of the trading is done at the Chicago Board of Trade or the New York Mercantile Exchange, although some trading is also done on the stock markets. These markets establish trading standards and units of measure for commodities, making them easy to trade. Corn contracts, for example, are for 5,000 bushels of corn, and the price is set in cents per bushel.

Commodities are often called futures because trades are made not for immediate delivery but for a later point in time, usually because it takes time for a good to be grown and harvested or extracted and refined. Corn futures, for example, have four delivery dates: March, May, July, September, or December. In textbook examples, commodities are usually sold for their marginal cost of production, though in the real world the price may be higher due to tariffs and other trade barriers. ​

The advantage to this kind of trading is that it allows growers and producers to receive their payments in advance, giving them liquid capital to invest in their business, take profits, reduce debt, or expand production. Buyers like futures, too, because they can take advantage of dips in the market to increase holdings. Like stocks, commodity markets are also vulnerable to market instability.

Prices for commodities don't just affect buyers and sellers; they also affect consumers. For example, an increase in the price of crude oil can cause prices for gasoline to rise, in turn making the cost of transporting goods more expensive.

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