Demand for Iron Ore from China - Assignment Example

Q1. a) The fall in demand for iron ore from China has two reasons. First, because of attempts to cool the housing market down has reduced the demand for construction steel which in turn has reduced the demand for iron ore. Secondly, the price of iron ore has also gone up leading to a decline in the quantity of iron ore demanded. b) Since a significant part of the demand for shipping is driven by iron ore trading, fall in iron ore trades leads to a reduction of demand for shipping. The effect is shown in the diagram above. As demand shifts down from original to its reduced level given the supply, the equilibrium price falls from P1 to P2. c) The concern is that the observation of falling prices of shipping could instead be caused by increase in supply since number of operators has increased. This is shown in the diagram below. Since there has been an increase in supply of shipping services for each given price, this implies an outward shift of the supply curve. As a result the Price drops from P1 to P2. The concern is that this may have been the reason behind the observed drop in prices. Q2. a) No, this would not be enough information to identify that the reason for the observed movements were entirely due to demand side factors. The rise in oil prices could increase wine prices through supply side effects as well. For instance if the increase in oil prices leads to a significant increase in transport costs, then this rise will be reflected in wine prices as well. But this is a supply side effect. However, since the correlation was as strong as 90%, it should be suspected that there was both a demand rise as well as a decline in supply together to generate the effect. Particularly, it should be noted that a rise in the CPI implies a steady rise in the prices of inputs for production of wine as well. Thus, taking these factors in consideration, it is not possible to conclude that the observed correlation stems entirely from demand side factors. Q2.b) No, even if we had information on the amounts traded over time, it would still not be enough to identify whether the changes were fed by demand or supply or a mix of both. A bi-variate graph of the traded amounts and prices would not carry information regarding whether the observed exchanges were being stimulated by changes in demand or that in supply or both. However, we could take more educated guesses given this set of information. For instance, if the observed transactions data showed that a negative relation ship between prices and quantities traded, it would be evident that the traced curve was a demand curve. Thus the changes that have caused the prices to fall were supply side effects. On the other hand if we observed a positive relationship, i.e., if we observe as prices rise, so do the traded amounts, the conclusion will be that it is the demand that is changing. But, it should be noted that such clean and precise one-to-one mappings are unlikely, and the only realistic conclusion can be that the observed changes reflect a combination of both demand and supply side factors. Q3.a) The situation may lead to a market crash since there is an excess supply of permits. This excess supply will lead to falling prices. And since demands are not rising for permits given the situation of the economy, if there is sufficiently high excess supply this will drive the market price down to very low levels and thus cause a market crash. Q3.b) The idea was to create high enough prices so that switching over to low carbon fuels. However, because of the low demands and excess supplies, market prices of permits have not risen to the degree that would make it profitable for producers to switch to low carbon fuels. As a result, the ETS has been unsuccessful in inducing firms to switch from using high-carbon to using low-carbon fuels. Q3.c) As shown in the diagram, assume that the government sets the reserve price at Pr. If the market operated freely, the equilibrium price would be Po and the equilibrium quantity would be Qo. By setting the reserve price at Pr, the government only sells Qr of its permits. Alternatively, the government by only bringing Qr units to the market could have pushed up the price of the permits to Pr. This is precisely the idea behind the auctioning mechanism. Now consider the auctioning mechanism. In the diagram above, suppose initially the reserve price is set at Pr. Evidently from the demand curve, for any price above Pp, there are no buyers for a single unit of the permit. In order to sell positive amounts the government would have to set a price below Pp. Suppose as in the graph above, government sets the reserve price to Pr1. As a result, Qr1 units are sold. If the reservation price is lowered, a larger number of permits will be sold, and each unit will be sold at the price that the buyer with the highest willingness to pay values the unit at. Thus, the government could have driven up the prices to Pr1 by bringing only Qr1 units to the market. Q4. a) Essentially the effect of the tax has been to shift the supply curve for cigarettes upwards to the left. For a single unit if Ps is the supply price and t is the tax then the price that the consumer faces is now Ps+t. The effect is shown in the diagram above. Po and Qo denote the pre-tax original equilibrium in the market. After imposition of the tax, the supply curve shifts upward reflecting that for the same quantity the consumer now has to pay a higher price. The new equilibrium price is Ps+t and the equilibrium quantity is Qt. b) Observe in the diagram below, the redline denotes a less elastic demand curve (steeper slope). Consequentially, the reduction in quantities sold from the same tax t would be less. Alternatively, in order to reduce consumption of cigarettes to Qt, the tax would have to be higher. Specifically it would have to be (Pt – Ps). Analogously, a more elastic demand would cause the higher reduction in quantities sold in the market, or require a lower tax to cause the same reduction in quantities sold. c) This is essentially the result of the fact that nicotine patches and gums are substitutes to cigarettes. Since the price the consumer pays for cigarettes has gone up, substitutes have now become more lucrative. In the initial situation where the tax rates was t causing a decline in cigarette consumption by (Qo – Qt), this difference was the amount of cigarettes not consumed. Imaginably, the demand for nicotine that was available from this quantity was instead derived from consuming nicotine producing substitutes such as gum and patches. Q5. a) World price rises from Wp1 to Wp2. As a result, the import of Maize falls from Qd1Qs1 to Qs2Qd2. To see this note that at price WP1, the domestic supply for Maize was Qs1 while the domestic demand was Qd1. Consequentially, the import was the difference. After the rise in world prices, the demand falls to Qd2 while the supply rises to Qs2. Consequentially the amount imported falls. Now Mexican Tortilla makers use maize as inputs. Since world price rises and the imports fall, the supply of input falls as a result increasing the price of Tortillas as inputs. b) The world price at which Maize is bought and sold falls. The impact can be visualized as a situation opposite to what we observed in part a. World price now falls from WP2 to WP1. As a result imports of Maize will increase. Local maize producers will supply less, Tortilla makers will demand more. Conceivably the income of the maize producers goes down. However welfare of the people is a tricky issue. While consumers of Maize and Tortillas are better off, domestic producers are worse off provided the price rise leads to a decline in producers surplus and increase in consumers surplus. However the relative magnitudes are essential issues and these involve computation of specific supply and demand elasticities. Further, if the decline in domestic prices leads to an increase in sales such that the profits of the producers increase, then the maize producers may be better off in spite of the subsidy. Additionally, if the maize producers themselves are consumers of Tortillas, then reduced prices of maize that causes declines in Tortilla prices may generate positive welfare effects that offset the loss in welfare caused by the subsidy. On the whole, consumers of Maize will be better off, while producers may be worse off. The net effect depends upon the relative magnitudes of the counteracting effects. Read More