What is a commodity?

For someone outside of the Wall Street marketplace, understanding the world of stocks, bonds, P E Ratios and some of the other jargon that’s used every day in the business section of the newspaper can be difficult. One such term that many people may use but not exactly understand is commodity. Most people know that commodities are traded like stocks and that they can be worth a lot of money, but if you ask more specifically, what is a commodity, many people wouldn’t be able to tell you.

So, what exactly is a commodity?

When talking about a commodity, there are a few qualities they usually have. Commodities are manufactured by more than one company and the quality of the commodity is the same from company to company. You wouldn’t be able to tell one companies product from another if you tried.

Sound confusing? It’s not, really. Things like oil, electricity and lumber are considered commodities. A product like, say, clothing wouldn’t be, because people can tell the difference between company A’s clothes and company B’s clothes. If you have a barrel of oil in front of you, it’s pretty much going to be the same as a barrel of oil from another company. The term that’s used in economics to describe this is product differentiation. If you can tell the two products apart, it’s not a commodity.

Historically, commodities are priced based on their “marginal cost,” which means the cost it takes to take the oil from the ground, barrel it and ship it. In today’s market, however, most commodities are priced higher based on things like one companies ability to do the job either faster or slower.

Other products fall into the commodity category like wheat, orange juice and pork bellies (the belly-part of a pig that bacon is made from). More recent commodities include Internet bandwidth and some computer chips.

A famous movie from the early 1980’s Trading Places was about a group of men who tried to make money on the commodities market. While the movie was fictitious, it showed how quickly large amounts of money can be made on the commodities market, and how quickly it can all be lost.

Understanding a little about what goes on on Wall Street can be a fun way to be introduced to the world of economics. While this introduction just skimmed the surface, the next time you hear someone mention commodities, you’ll know exactly what their talking about.

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