Economics of Demand, Supply and the Concept of Elasticity - Assignment Example

Economics of Demand, supply and the concept of Elasticity Name Institution Question (I) The statement holds because increased demand for pork is an indication that consumers are compelled to spend more on pork as opposed to beef. The fall in local consumption of beef has been because of increasing demand for beef thus higher prices that lowered the supply of beef in the Australian market. This affects the supply curve of beef as denoted by a shift to the left of the supply curve, and decreased demand (Chen, 2001). This can be shown below, Price S s0 p0 P D Q0 Q Quantity of beef The supply curve of beef has shifted from s0 to S l, further increasing the prices from P to p0 and subsequently reduces the quantity demanded from Q to Q0. Since pork and beef are substitutes, increasing beef prices will shift the pork demand curve to the right as consumers opt to consume pork hence its increased demand. Buyers will therefore buy more units of pork to make up for the reduced units of beef thus increasing the demand for pork .Additionally, when the pork producers expect the high prices to prevail for some time, they will limit the supply so as to maintain the high prices only in the short run. In the long run, the supply of pork will increase plunging the prices below the equilibrium price. This is in conformance with the law of supply where suppliers are only willing to supply more of their commodities at higher prices (Chauhan & Chauhan, 2009). This can be shown as below; S S0 P1 P0 D Q0 Q1 Quantity of pork Supply of pork increased from S to S0 and reduced the equilibrium price from P1 to P0 while the quantity of pork demanded increased from Q0 to Q1. The price of pork increases with increase in grain prices without having to undermine the demand for pork. This implies that pork has an inelastic demand because change in prices result to a change in quantity demanded which is less than proportionate. The implication is that pork is deemed as a necessity in the Australian market (Henzell, 2007). However, the demand for beef is price elastic because a change in price results to more than a proportionate change in the quantity of beef demand. This implies that beef is deemed as a luxury by the Australian consumers and is connoted by the reduced demand. Question (ii) The value share of beef slightly dropped from 38 pc to 36 pc because of increased cattle slaughter due to drought, which increased supply and pushed down the prices as a result. This key point in relation to demand and supply of both beef can be shown in the diagram below, Price S S1 P P1 D Q Q1 quantity of beef In the diagram above, the supply of beef increased from S to S1 which changed the equilibrium price and quantity from P to P1 and from Q to Q1 respectively. The increased supply therefore pushed down prices from P to P1. Because pork and beef are substitute goods, the reduction in beef prices will lead to a reduction in demand for pork as consumers now can buy more beef to derive the same utility from their basket of commodities. This will decrease the price and supply of pork. This has been shown in the diagram below. In the diagram, the quantity demanded for pork declined from D to D1 (downward shift of the demand curve) and decreased the price from P1 to P0 and quantity from Q1 to Q0. Price D1 D S p1 p0 Q0 Q1 quantity of pork Another key point is the reduction in numbers of sows as the pork farmers adjust to the introduced husbandry practices. This can be shown in the diagram below even though it may not affect the production of pork significantly, P S1 P0 S P1 D1 Quantity of pork Q0 Q1 The quantity of pork supplied will reduce as denoted by the leftward shift of the supply curve from S to S1. This will have an effect of increasing the price of pork from P1 to P0 and reduce the quantity demanded from Q1 to Q0. Because pork and beef are substitute goods, increase in price of pork due to low supply will lead consumers to consume more beef so as to derive the same levels of utility (Saada, 2009). As a result, the demand for beef will subsequently increase with increase in the quantity demanded. This can be diagrammatically shown as below -: P D1 D0 S P0 P1 Q1 Q0 quantity of beef The demand for beef increased from D0 to D1 due to high prices of pork and increased the price from P1 to P0 while increasing the quantity demanded from Q1 to Q0. Question 2 (I) Price S1 S0 p1 P3 p2 P0 D1 D0 Q2 Q0 Q1 Q3 quantity of sorghum From the above diagram, the supply of sorghum reduced as the crop was drought depleted. This has been reflected by the upward shift of the supply curve from S0 to S1 and increases the price from P0 to P2 hence the prices of sorghum continue being stronger. In addition, the China’s thirst for baijiu, which is distilled from sorghum, has increased the demand of sorghum from D0 to D1, which again increases the prices from Po to P3 as the quantity demanded increases from Q1 to Q3. This compounds the strong prices of sorghum. Eventually, the interaction of the forces of demand and supply will come up with a new equilibrium price and quantity of sorghum, which will be P1 and Q1 respectively as reflected, by the new demand and supply curve. Question 2 (ii) The derived demand for Australian sorghum is price inelastic because changes in prices of sorghum result to changes in quantity demanded which is less than proportionate. In this case the PED < 1 implying that the commodity is a necessity (Wong, Selvanathan & Selvanathan, 2013). The situation is favorable only from the supplier’s viewpoint because the total revenue and price are directly related and price increments will end up pushing the total revenue upwards notwithstanding the decrease in quantity demanded (Chauhan & Chauhan, 2009). The degree of necessity will have an impact on the derived demand of sorghum in the sense that the higher the degree of necessity the higher the demand of sorghum. This will have an effect of increasing the degree of inelasticity of sorghum as the higher the degree of necessity the more inelastic the price elasticity of demand (Henzell, 2007). For commodities that are absolute necessities, the price elasticity is perfectly inelastic. Another factor that will undermine the derived demand of sorghum is the availability if close substitutes. When sorghum has close substitutes, any increase in price will have the derived demand for sorghum declining as the consumers now resort to the cheaper substitutes (Chen, 2001). This will affect the price elasticity of demand for sorghum, because a small change in price for sorghum will result in a more than proportionate change in quantity demanded. The PED>1 and this is because the consumers will opt to buy the substitute as opposed to the highly priced sorghum. Sorghum will be deemed a luxury. Derived demand will also be subject to the size of the market whereby the larger the market size the higher the quantity demanded because a bigger market is affiliated with large populations and lower trade barriers as well. This will have an effect of lowering the price elasticity of sorghum, competition becomes intense, and the markup falls (Chauhan & Chauhan 2009). Question 2 (iii) The primary supply of Australian sorghum will be inelastic because the supply of agricultural products will be inelastic in the short run. This is because it takes times for the farmers to grow their produce and will not be in a position to increase the supply of sorghum in response to price increments due to the time lapse between producing goods, harvesting and taking them to the market for the final consumers (Wong, Selvanathan & Selvanathan, 2013). However, in the long run, producers will have ample time to change production processes as production patterns may be altered and more labor might be deployed hence the elasticity of supply will be higher only in the long run (Saada, 2009). The high price elasticity will imply that when prices of sorghum go up, producers will supply less and supply more when the price goes down. Price elasticity of supply in this case will therefore be greater than 1 (PEoS>1) as it will be denoted by a positive coefficient. A factor that will influence own price elasticity of supply is the ease at which the producers can switch to the production of other goods (Jain & Khanna, 2008). Producers whose operations are close to full capacity and cannot easily switch to production of other commodities face inelastic supply as it might be difficult to change the production processes and labor force at the same time more so in the short run because of fixed capital (Chatnani, 2010). Additionally, the lack of available stock will render the supply of sorghum as inelastic because producers will not have buffer stock to counteract the any increase in supply that may result. Own price elasticity of sorghum will also be influenced by the levels of employment of the available resources in that the supply will be inelastic only when the available resources are fully employed and elastic when resource deployment is low (Guisán & María, 2005).. This is because it becomes difficult to employ factors of production where highly skilled labor is needed (Wong, Selvanathan & Selvanathan, 2013) Question 2 (IV) Sorghum will have a strong cross elasticity of supply with a product that is complementary such as baijiu. According to the law of supply, producers will supply more sorghum at higher prices and this will see the supply of baijiu go up as well because the producers of baijiu will also supply more of the product at the prevailing high prices. As the price of sorghum increases, the supply of baijiu increases implying the strong (positive) cross price elasticity of supply as the two goods are complementary and not substitutes (Chatnani, 2010). As for negative cross price elasticity of supply, it is more prevalent among substitute goods where the increase in supply of one commodity will be due to high prices lower the demand of that commodity because consumers will now consume more of the substitute, which is now cheaper (Guisán & María, 2005). Due to the lower price of the substitute, suppliers will not be willing to supply more of their products and may hoard them in prospects of future increase in prices. Therefore, the increased supply of sorghum will reduce the supply of the substitute. This explains the negative cross price elasticity subsisting in substitute goods (Jain & Khanna, 2008). The cross price elasticity of supply will be influenced by the production capacity of sorghum where spare capacity or excess supply may force producers to increase their output without necessarily having to experience cost increments causing the supply to be elastic due to the changes in demand patterns (Chen, 2001). This can be attributed to the fact that the supply of either goods or services becomes even more elastic during a recession when capital resources and spare labor are abundant. Stock of finished products will also have an effect on the cross price elasticity of supply because if finished products that need to be supplied are at higher levels, producers will be in a position to respond to any changes in demand causing supply to be inelastic (Guisán & Marí, 2005). Conversely, whenever the supply of finished products is low, supply will dwindle and eventually increase the prices due to the scarcity of the commodity. Price elasticity of supply of sorghum will be inelastic and will be less than one (PES Read More