The Concept of Income Elasticity of Demand for Wheat - Assignment Example

Business Economics work Assignment How did the wheat price change between 2001 and2011. Wheat prices changed between 2001 and 2011 due the forces of supply and demand. Supply of wheat has been lessened by droughts and shift to other uses aside from food. Other factors that explain wheat price change are the rapidly increasing costs of oil prices and the continuing devaluation of the US dollar. The US dollar is used as an economic indicator in quoting pricing for commodities. Droughts caused wheat production to decline in some wheat producing countries. Middle East suffered a decline of wheat production of 7.4 million tons or about 19 percent because of the worst drought the country had experienced in 2008. (Commodity Intelligence Report, 15 December 2008) China and Iran, had each, reported worse effects of droughts to wheat crops. Drought in China as of October, 2010 had affected 7.73 million hectares of wheat plantation (China Daily). Iran estimated a decline of their 2008 production by 20% due to effects of drought (USDA Foreign Agricultural Service. 15 December 2008). A decline in production would mean a gap in supply and demand that raises price. The price of wheat is also affected by the weakening US dollar because this will mean a decline in the purchasing power of a dollar. The U.S. dollar is a world trading currency; meaning all prices of commodities are linked to its price, and devaluation would have a great impact to international trade. In anticipation of devaluation, all countries will immediately raise their prices. Commodities such as wheat, oil, coffee, etc. will now set their price records to protect their investments. Farmers know that the dollars they are receiving for the wheat is declining in purchasing power, so they have to adjust their prices in anticipation for the devaluation; that is why we have a higher price of wheat now. As an example, if the US dollar declines by 30%, and the farmer has $1 million in wheat, his million dollars will now be able to buy $700,000 worth of goods or services, so he lost $300,000 in purchasing power. 2. Identify the factors that determine the demand for goods and services in general? Consider how these factors affect the demand for wheat. In general, determinants of demand are income, tastes, prices of related goods and services, expectations and the number of buyers. We know that if we lower the price of a good without altering its quality or quantity, people will flock to you to buy as this the law of demand. We will illustrate the law of demand by example in demand for wheat. The law of demand applies to a well defined good – the wheat. Then the second phase indicates that people must not only want to purchase the wheat but must be able to purchase the wheat in order to be counted as part of demand. But although willing, consumer is not able at the price of $111.00, so buyer thinks of something else to replace the need for wheat. The next step is to think of the price and quantity demanded; that is as the price rises, the quantity demanded falls, and as the price falls, the quantity demanded increases. 3. What are the major factors increasing the demand for wheat? [Make sure you use the concept of income elasticity of demand for wheat (Ardy, 2010, p. 5). The factors that increase demand for wheat are price, price of substitute goods; preferences, population and income. These factors are discussed in the following paragraphs. Price. As the price of wheat increases, assuming that all other factors remain equal, less people would demand for wheat. The demand slope is downward looking . As the price of wheat increases, people would naturally avoid consumption and look for substitute products that they would value more. The price of substitute goods. A substitute product is a good or service which may be bought instead of another when the price of the latter changes or if it becomes unavailable. For instance, the increase in wheat price will increase in the demand for corn, potatoes and rice and other staple food. If substitution is easy and viable, demand for wheat is lessened, so in this manner, demand is positively related to the price of substitutes. Preferences. Porter’s 5 Forces of Analysis (QuickMBA) considers looking for substitute products as switching. For the reason of rising costs, people would turn to substitute products like corn, potatoes and rice. However, switching to alternative food is unlikely because of food preferences, culture and taste, so this is a weak factor to consider in the short range and could be of value in the long range due to changes of lifestyles. Population - An increase in the number of potential buyers also increases demand. In 2011, world population has reached 6,956,912,235. India, China and Japan are the largest populated countries and the smallest are Panama, Namibia and Guinea-Bissau. Income. The income effect is described as when the income of a person increases, other things remaining the same, that person will demand more goods or services. The income elasticity of demand could be calculated as: Percentage change in quantity demanded of wheat divided by the percentage change in real consumers' income Price elasticity generally is negative. A price elasticity of -1.2 means that a 1 percent price increase will lead to a 1.2 percent decrease in the quantity demanded of the good in question. In this case, demand is called elastic. It is reported that for staple foods the price elasticity of demand lies between -1 and 0, becoming less elastic for household with higher incomes. The values found for developing countries are found between -0.5 and -0.3 .) Necessities have an income elasticity of between 0 and +1. Demand rises with income but less proportionately (Market Analysis Tool Price and income elasticity) 4.Between May 2007 and March 2008 the price of wheat increased by 120%. Assuming that this is the price charged to consumers and that no other factor affecting the demand for wheat has changed, calculate the % reduction in the demand for wheat in the UK and China? Explain your answer. [Use the concept of own price elasticity of demand (Ardy, 2010, p.3-4] A. China Assume that the price of wheat increased by 120% Price elasticity of demand for wheat = % change in the quantity demanded of wheat % change in the price of wheat % change in the price of wheat – 120% % change in the quantity demanded of wheat in UK Demand of wheat 2007 78.4 Demand of wheat 2008 111.1 Percentage change = 41.709 Price elasticity = 41.709 divided by 120% = 0.347 This means that if the change of price is 120%, reduction in the demand would be 41%. Price is elastic meaning price change will result to an even larger change in quantity demanded B. UK Demand of wheat 2007 - 150 Demand of wheat 2008 – 138.6 Percentage change 7.6% decrease Price elasticity 7.6% divided by 120% = 6.33% A price change of 120% would mean a reduction of 6.33% in demand. Price is elastic. 5. Describe the trend and the fluctuations in the production of wheat since 2001 (See Figure 2). [This question asks you to describe, no explanation of why production has changed is necessary.] The trend or prevailing tendency of World Wheat Production in Fig. 2 shows a rising production that started in 2000 reaching a peak in 2009, and start of a declining production in 2011. However it has not returned to its original level in 2001. In year 2001 trend of production is maintained with slight decline up to 2004. Production stays at a maintained level in 2007 to 2008. Demand for wheat started to increase in 2008 and stayed that way until 2010. Although there have been minor fluctuations in 2004, yields have increased since 2005 up to 2011. 6.Explain why wheat yields have been rising? Wheat yields have been increasing because of technical progress and innovations in the production processes. Wheat yields increases because of production methodology that could be intensive, extensive and capitalistic. Majority of the farms in EU are mechanized and production is boost by expanded areas. In US, farms are relatively larger than those in EU, but they are also mechanized. The growing number of small farm production of wheat in India and China are further boosters of wheat yields.(MOMAGRI) 7.Do you think wheat yields will continue to rise in the future? Justify your answer. Wheat yields will continue to rise in the future because of the continued research and development that will improve the variety. The emergence of new countries like China and India contributes to world wheat production will ensure the continued rise in yield of wheat. New area development, technologies, breeding and other scientific process are assurances coming from the government that supports yield of wheat harvests. Plant breeders are expected to increase production by 50% in 2050 due to plant protection techniques and conversion of arable land to wheat production. Wheat is a staple food, and the continued increase in yield per hectare is a continuing effort of research. 8.Why is the wheat price so unstable? [Use a supply and demand diagram. Refer to the own price elasticity of demand for wheat, see Ardy, 2010, p.3-4.] Below is a graph of demand that defines the relationship of price, quantity and demand. A, B, C, are points in the demand curve that reflects changes in prices at different points. Let us assume Point C is the price of wheat in China in 2008, and Point A is the change in price in 2009. The demand relationship curve shows a negative relationship between price and quantity demanded the price elasticity. The graph illustrates that the higher the price of wheat, the lower will be the quantity demanded, and the lower the price, the more good will be in demand. The diagram of supply below shows an inverse situation wherein slope is shown to be going up. This means producers are happier with increase in prices, and is ready to supply more as prices increase. So, if the price of wheat goes to $111.9 or higher, wheat producers would be happy to supply demand requirement. 9.Why did the price of wheat fall between March 2008 and May 2010? Global wheat prices declined by 20 percent between July 2008 and June 2009. According to analyst insight of Redruello (2010), drop was prompted by the weak demand for bakery products and the worsening of economic growth expectations worldwide. This analysis presented a healthy view of wheat stocks as against a weakening demand. The decline is triggered by the change in lifestyle like concerns in obesity in North America. Decline in bread consumption is also reported in Russia, EU and for global demand for intensive wheat packaged food category. 10.Why did the price of wheat rise between June 2010 and May 2011? The weather disturbances in large producing regions and export restriction of other countries have restricted wheat production and caused prices to double between June 2010 and May 2011. On the supply side, Prices are kept high because of uncertainty of supply coming from Australia where wheat crops were damaged by excessive rains and floods. Concerns of same nature are directed to China’s winter wheat crops. Prices will most likely remain high when demand from the Middle East and North Africa comes with large orders and there is a need to assure the public that there is an adequate supply of domestic food during uncertain political times. Another cause is the concern for environment as countries like Saudi Arabia are reducing domestic production of wheat to conserve valuable water resources and therefore would rely more on imports.(The World Bank). REFERENCES China Daily, 09 February 2011. Gov/t warns continuous drought in SpringViewed 22 August 2011. http://www.chinadaily.com.cn/china/2011-02/09/content_11972807.htm. 02.09.2011. Commodity Intelligence Report, 15 December 2008, USDA Foreign Agriculture Service. Viewed 22 August 2011 http://www.pecad.fas.usda.gov/highlights/2008/12/mideast/. Market Analysis Tool, price and income elasticity. WFP. Org. Viewed 22 August 2011 www.wfp.org/content/market-analysis-tool-price-and-income-elasticities QuickMBA. Porter’s Five Forces. Strategic Management. A Model for Industry Analysis. Viewed 22 22 August 2011 http://www.quickmba.com/strategy/porter.shtml Redruello Francisco. 19 August 2010. Global wheat price forecast for 2010 and 2011. Euromonitor International. http://blog.euromonitor.com/2010/08/global-wheat-price-forceast-for-2010-and-2011.html The World Bank. February 2011. Food Price Watch. February 2011. http://www.worldbank.org/foodcrisis/food_price_watch_report_feb2011.html World population. 2011. Viewed 22 August 2011http://www.census.gov/main/www/popclock.html Momagiri.org. Wheat: a strategic market on which prices could become more and more volatile. Viewed 22 August 2011 http://www.momagri.org/UK/focus-on-issues/Wheat-a-strategic-market-on-which-prices-could-become-more-and-more-volatile_138.html Read More