Budget Line Analysis - Essay Example

? MICROECONOMICS 200 ASSIGNMENT SEMESTER Part A i) Demand refers to the quantity of goods or service that consumers desire to have at a given price. The law of demand says that as price of a product goes up, its quantity demanded falls, with other things held constant. The reason for it is that as the price goes up the opportunity cost of buying it also rises so people are willing to forgo its consumption and look for alternatives. The graph below shows demand function. As the price decreases, more consumers are willing and able to buy more of the product and vice versa, hence the downward sloping curve. The factors that commonly influence demand conditions (with other things held constant) are, changes in tastes and preferences, income of people influences the demand of normal and inferior goods, changes in the size of population, weather, changing expectations and prices of other related goods such as substitutes and complements. Changes in these factors will shift the demand curve. As the demand for bio-fuels increase, this will result in a higher level of production of bio-fuels. Bio-fuel usually use both corn and sugar as inputs where the yield of these crops is utilized in the production process (Vidal n.d.) As a result of an increase in demand of the bio-fuel, a substantial rise was reported in the demand of corn. Corn is now required as a source of food as well as an input for bio-fuel production. The image shows the increase in price as a result of the increase in demand of crops. The previous demand used to be D1 which was added with the demand of crops for bio-fuels and this resulted in the new demand curve D1+D2. This graph also shows how an addition to the demand has resulted in the increase of prices of crops to PC*. If the increased demand is not addressed by added production, then the prices rise because the market forces come into play and determine the market prices (AmosWEB n.d.). The above graph shows that the supply curve does not shift and merely extended and as a result the prices have increased. ii) Supply refers to the quantity of a product that the producers are willing and ready to produce at a given price. The graph below shows supply function. The supply function is upward sloping. This is because the greater the price, the greater will be incentive to produce more and hence the supply will increase. Changes in supply curve can occur because of a number of reasons such as change in technology, the cost of producing other goods and services such as substitutes, taxes and subsidies, changes in input costs, number of producers in the market and weather. Change in these factors causes the supply curve to shift. In this case, since the product under consideration is corn which is an agricultural product, it is a difficult task to enter the industry of producing corn because there is often a limitation of land availability. The optimum solution seems to improve the agricultural and conversion technology. If there is an improvement in the seed quality, then it will result in a greater yield which will increase the supply. Also, there is often wastage in the conversion process but this wastage can be controlled if a new technique and technology is introduced. This will result in added supply available for consumption and thus the overall supply increases. As the supply increases in this case, the prices of the crops will go down. Here, the image on the right shows that the increase in demand has shifted the curve towards the right, even the supply curve is shifted to the right because of improvement in production techniques. This increase in supply is greater than the increase in demand and has helped to keep the price down despite the increase in demand. In our case, the supply of the crop has increased as a result of an improvement in agricultural and conversion technology and this will result in keeping the prices lower. iii) The bio-fuels are the new addition in the oils industry throughout the world. The formulation of ethanol has addressed the growing concerns of non-replaceable fuel depletion on this planet. The bio-fuels have added to the competition in the oil industry and the companies have faced increased competition in the industry. Bio-fuel consists of oil extracted and produced from agricultural output through new technologies, therefore the costs of production look likely to reduce in the future with the improvements in technology. When the competition arises in an industry, it puts the pressure on the competitors to lower the prices. The consumers have an increased number of alternatives now to choose from and this gives them a freedom to choose among the available options. When bio-fuel entered the industry, it added to the alternatives available for the consumers. As a result, competitors have to reduce their prices to maintain the popularity and demand of their products. (Economic Times n.d.) If the prices of bio-fuels go down, then consumers can switch to bio-fuel because they can get more value in terms of environment friendly fuel at a lower cost. This will put more pressure on the competitors and they will be forced to reduce their prices. Also, the availability of alternatives increases the price elasticity of demand or PED. The Price Elasticity of Demand is the responsiveness of demand as a result of changes in price (Moffatt n.d.). Therefore a high price elasticity of demand means that if there is a price change, then the demand for that product will change in the opposite direction by a greater proportion. As a result, the competitors in the oil industry will lower their prices to remain competitive. Part B i) The case mentions that a substantial part of crops is now utilized as input to the production and extraction of bio-fuels. There is an increase in the demand for crops such as corn, and since it is a difficult task to increase the production of crops and hence supply, the prices of crops tend to rise. The price of crop will increase as a result of increased demand, and the price of fuel will reduce due to greater competition of products. Change in the price of these two products which are fuel and food have a considerable influence on the living standards of people. Usually the low income people spend most of their incomes on the consumption of food and little on fuel. Therefore, the rise in prices of food and decrease in prices of fuel has a great negative effect on their consumption trends. The figure on the right shows the budget line for low income people. A budget line is a graph showing all the combination of a couple of items which can be consumed simultaneously in a limited budget (EconGuru n.d.). In the case of low income people, a large proportion of their little disposable income is spent on food. The red line shows the previous consumption pattern where 80 units of food could have been consumed given that all the income is spent on food. The green line however, shows the new consumption patterns after the changes in prices of the two products. It can be clearly seen that now only 55 units of food can be purchased under the same circumstance. The price of food has increased by a large margin but the price of fuel has decreased by a lower margin. Therefore it creates more problems for the low income people because they do not spend substantial amounts of money on fuel but they do spend a lot on food.. ii) The high income class has an advantage as the prices of the two products change. The high income people have large disposable incomes and so only a small part of their incomes are spent towards food. As a result when the price of food increases, it only has a limited negative impact on the food consumption because it does not influence their disposable expenditure significantly. On the other hand, high income people usually spend a lot on fuel due to their travelling patterns. With a decrease in the prices of fuel, they can increase the consumption of fuel with the same amount of money. The graph on the right shows the budget line of high income people. Here it clearly shows that a major part of their incomes are spent on fuel wile a smaller proportion of income is spent on food as compared to the low income people. Here, the budget line is in a much favorable position and they can spend more on fuel due to its fall in price. The rise in price of food has not affected the food consumption substantially because the high income class spends small portion of their income on food. Part C Governments should ensure the availability of food product in their country because it a basic requirement of living. In this case, the rising demand of corn for bio-fuels has increased its prices and therefore made it less affordable for the general public. The government needs to introduce policies to keep the situation under control for the good of the society. The government should allocate funds for research and development on the production and extraction of bio-fuels should be promoted (Hsu n.d.). This research and development will help in discovering cheaper and alternate inputs for bio-fuels and therefore it will help to bring down the prices of fuel as well as keep the prices of corn under control since it is no longer used as an input. Hydro and solar energy run cars can prove to be extremely beneficial for economies because the help to conserve precious fuel and assist in carrying out normal activities without much damage to the environment. The government should assign a quota of consumption of corn towards the production of bio-fuels. At the moment, too much corn is used for bio-fuels which are putting an upward pressure on the price corn and this need to be addressed. If a quota is put into place, then the majority of corn will be available for consumption as food and make it affordable for people. The government can encourage the use of public transport to control fuel consumption for travelling. The success of this factor will require the collective effort of the society and cooperation to ensure a better future. Therefore the government should implement these policies so that the whole society can benefit for future. Works Cited AmosWEB. Demand Increase. http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=demand+increase. EconGuru. Budget Line. http://glossary.econguru.com/economic-term/budget+line. Economic Times. New competition policy will bring down food prices. http://articles.economictimes.indiatimes.com/2012-02-06/news/31030615_1_competition-policy-competition-law-foodgrain-prices. Hsu, Jeremy. U.S. Government Invests $78 Million in Algae Biofuels Research. http://www.popsci.com/technology/article/2010-01/us-government-throws-78-million-algae-biofuels-research. International Food Policy Research Institute. Global Response Needed to Rising Food Prices. http://www.ifpri.org/pressrelease/global-response-needed-rising-food-prices?print. Moffatt, Mike. Price Elasticity of Demand. http://economics.about.com/cs/micfrohelp/a/priceelasticity.htm. Oxford Analytica. Biofuel Benefits Go Beyond Environment. http://www.forbes.com/2006/04/07/biofuel-benefit-ethanol-cx_0410oxford.html. Vidal, John. US corn production and use for fuel ethanol. http://www.guardian.co.uk/environment/datablog/2010/jan/22/us-corn-production-biofuel-ethanol. Read More