Download Agricultural Marketing

Agricultural Marketing
SAB – 103
T-R: 11.00 am – 12.15 pm
Fall 2016
Instructor: Sankalp Sharma
Email: [email protected]
Who am I?
A word on my teaching philosophy
About this class
- In class expectation
- Out of class expectation
- Homework
- Grading
In-class Expectation
- Key to learning: interaction
- Review previous class’ notes before class (same file will be updated)
- Attend all classes (cannot emphasize enough)
Ask questions…
But don’t be a troll!
No cellphones or laptops during the class !!
Out-of-class Expectation
- No gains without practice.
- Reading not enough, you must practice problems.
- Form groups to practice.
- Understand the concept, memorization won’t help you.
Homework
- Frequently assigned.
- Usually only one question.
- A random student will be asked to solve the HW on the
board.
Grading
- Exams will be long and difficult.
- Everything taught in class is fair game.
- But grading will be easy.
- 40% midterm, 40% final, 20% HW, (bonus: 20% class interaction)
Questions?
The Road Map
-
Introduction to Agricultural Marketing
Basics of Supply and Demand
Elasticities
Equilibrium Displacement Models
Food Marketing Channel
Spatial Concepts in Agricultural Markets
Inter-regional trade
Introduction to Agricultural Marketing
- What is marketing?
- What’s special about agricultural markets?
- Role of prices
Basics of Demand & Supply
-
Demand
Aggregate Demand
Supply
Aggregate Supply
Equilibrium
Solving for Equilibrium
Elasticities
-
Demand Elasticities
Properties of Demand Elasticities
Cross Price Elasticities & Their Properties
Price Elasticities of Demand in Agricultural Markets
Elasticities of Supply
Equilibrium Displacement Models (EDMs)
- Single Commodity EDM
- General Equilibrium Displacement Models (GEDM)
Food Marketing Channel
- Derived Demand
- Derived Demand Graphical Analysis
- Derived Demand Numerical Analysis
Spatial Concepts in Agricultural Markets
- Economies of Scale
- One-dimensional Spatial Model
- Overlapping production regions
Inter-regional trade
- Deriving the excess demand curve
- Deriving the excess supply curve
- Trade
- Trade with transportation cost
- Welfare analysis of trade
International Trade & Exchange Rates
-
Politics of Trade
Trade Restrictions
Exchange Rate Basics
Trade with Exchange Rates
Modelling Trade with Exchange Rates
Introduction to Agricultural Marketing
Typical issues:
-
Grain / cattle prices: high volatility
Inability to hedge risk
Issues in foreign nations – trade agreements falter
Economic downturn and effects on agricultural markets
What is “Marketing”?
What is “Marketing”?
- Change of agricultural and food products
- Link between agricultural and food products
- Three aspects:
- Transactions occur across space
- transactions occur across time
- transactions occur in a certain form
Facets of Marketing
- How does the supply of food become available to those who demand
it?
- Both suppliers and consumers are part of markets and marketing.
- Locations where buyers and sellers meet
- Broader context: U.S. wheat market; World wheat market.
- Transportation
- Storage
What's special about agricultural markets?
- Fixed periods of production and seasonality growing seasons are
established; seasonality affects demand.
- Risk of perishability - risk that good will become unusable.
- Weather and other unpredictable events - frost, hail, drought.
- Invasive species - karnal bunt; grasshoppers; wheat stem rust; BSE.
- Potential for high price volatility.
- Competitive markets (price taking environment) - supply and demand
determine prices; producers accept these prices when they sell, and
consumers accept these prices when they buy.
Role of prices
- Price is a signal for production and consumption.
- Government can play a large role in affecting prices in agricultural
markets.
- Knowing and predicting future prices is very important (but extremely
hard to do).
So let’s begin…
Basics of Demand & Supply
-
“What I need”  “is what I want”
-
“what I want” is nothing but “demand” for that good.
-
“but what I want” must be produced.
-
…… “ and thus there must be supply”.
- But where is this “demand” coming from?
In Economics everything comes down to
“Utility”
What is utility?
- Don’t confuse it with the English definition!
What is utility?
A set of “wants”/ “preferences”
What does a typical utility function (U) look like?
U(.)
Food, wealth,
health, etc.
What does “my” utility function look like?
U(.)
Food, travel, health,
swimming, relationship
with significant other,
Game of Thrones
Therefore, more formally:
Utility
Demand
Supply
Equilibrium
Not always the case though, sometimes
-
Utility
Demand
Supply / Producer
Equilibrium
Demand explained, more formally
- Illustrates all quantities desired at every alternative price.
- Marginal value of the last consumed unit.
- Downward sloping. (Law of Demand)
Law of Demand: “All things being equal, as the price of a good
increases, the quantity demanded falls & vice-versa”
** The “good” in this case must be a “normal” good.
-
Demand Schedule
- Demand schedule is nothing but a table that lists all combinations of
price and quantities demanded.
*Usually there is an inverse relationship. Example:
Price
Quantity
1
8
2
4
3
2
4
1
Graphically
Price
P*
q*
Quantity
Properties of Demand Curves
- Demand curve is steeper if:
-There are no close substitutes.
-There is a short time considered.
- A price change indicates a movement on the demand curve.
Numerical interpretation
Price
What is the
mathematical
representation of this
line?
P*
q*
Quantity
Numerical Example
Albus Dumbledore is a “butterbeer” enthusiast at Hogsmeade. His
demand for “butterbeer” can be given by:
𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = 10 − 2𝑝𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟
How many butterbeers would he have, if he pays:
Price
Quantity
1
?
2
?
3
?
4
?
Example continued
Dumbledore’s good friend Cornelius Fudge also likes butterbeer.
However, his demand schedule looks different:
𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = 10 - 𝑝𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟
How many butterbeers would he have, if he pays:
Price
Quantity
1
?
2
?
3
?
4
?
Example - continued, draw both demands on
the same graph
Aggregate Demand
- Minerva Mcgonagall and Madam Rosmerta also visit Hogsmeade for
butterbeer.
Their demand functions are:
𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = 20 − 3𝑝𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟
𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = 11 − 3𝑝𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟
If Dumbledore, Fudge, Mcgonagall and Rosmerta comprise the entire
market. What is the aggregate demand for Butterbeer?
Solution?
How would you graph the aggregate demand
function?
Properties of Aggregate demand
- As more consumers are added to the aggregate demand curve, the
the curve becomes flatter.
- Structure and competition among packing and retail sectors.
- Population in the U.S
- Demographics of the U.S population.
Consumer Surplus
- Even if the price goes up, the consumer is still willing-to-pay to an
extent.
Price
CS
P*
q*
Calculating: Consumer Surplus
Find the CS for:
-
Dumbledore
Fudge
McGonagall
Rosemerta
Homework 1: Demand & CS
- Anakin Skywalker and Obi-Wan Kenobi are in the market for lightsabers.
Their demand functions are as follows:
Anakin: 𝑞𝑙𝑠 = 100 − 10𝑝𝑙𝑠
Obi-Wan: 𝑞𝑙𝑠 = 24 − 4𝑝𝑙𝑠
Find Anakin’s quantity demanded when the prices are: $1, $2 and $5
Find Obi-Wan’s quantity demanded when the prices are: $1, $2 and $3
Graph both demand curves and find the Consumer Surplus for each of them
Solution?
Anakin:
Solution?
Obi-Wan:
Midterm
- Tuesday 1st November, 2016
Shifts in the demand curve
Common causes:
- Shift in the relative price of goods.
- Increase or decrease in income.
Price
P*
New demand curve
original demand
curve
q*
Quantity
The Supply Curve
Intuition, where is the supply curve coming from?
- How would I graph the supply curve?
Graph of a supply curve
Aberforth Dumbledore, Bill Weasley and Fleur Delacour are “butterbeer”
suppliers in Hogsmeade.
Graph the following curves:
Aberforth: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = −15 + 2𝑃𝑤ℎ𝑒𝑎𝑡
Bill: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = −20 + 2.5𝑃𝑤ℎ𝑒𝑎𝑡
Fleur: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = −10 + 3.5𝑃𝑤ℎ𝑒𝑎𝑡
Graphs?
Supply curve:
- Illustrates all quantities supplied at every alternative price.
- Describes the marginal cost of the last produced unit.
- Upward sloping (Law of Supply). For a normal good, as price
increases, the quantity supplied increases.
In competitive markets
- In competitive markets:
Output price = marginal cost
What is marginal cost: “is the cost added by producing one extra unit”.
Implying that firms do not make a profit.
What changes supply?
- Change in price will result in a movement along the supply curve.
- Fixed costs exist only in the short run.
- Change to an external factor will shift the supply curve.
- Relative price of inputs.
- Creation and adoption of technology (e.g., GM crops, farming
equipment).
- Price of other related products (e.g., ethanol demand caused
acreage to be turned over to corn at the expense of soybeans).
- Weather.
Market Supply
- Same idea as before:
- Just as with aggregate demand, horizontal aggregation is used to
derive the market supply curve.
Find Market supply of producers in
Hogsmeade? Graph it
Producer’s Surplus (PS)
- Producer surplus (PS) is the amount of value the rm receives above
the marginal cost incurred to produce and sell the good. It is measured
as the area above the supply curve, bounded by the sales price.
PS: Graph
Equilibrium
- Equilibrium is Characterized by the Crossing of the Supply and
Demand Curves
Supply
CS
P*
PS
Demand
q*
Question
- Find equilibrium price and quantity for the following demand and
supply curves:
- Once you do that find CS and PS
- Graph the curves.
Demand: 𝑞𝑠 = 250 − 25𝑝𝑠
Supply: 𝑞𝑠 = −200 + 50𝑝𝑠
Solution?
Homework 2: Find the Market Equilibrium in
Hogsmeade
Demands of Albus, Cornelius and Minerva are:
Albus: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = 10 − 2𝑝𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟
Cornelius: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = 10 − 𝑝𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟
Minerva: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = 20 − 3𝑝𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟
The supply curves for Aberforth, Bill and Fleur are:
Aberforth: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = −15 + 2𝑃𝑤ℎ𝑒𝑎𝑡
Bill: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = −20 + 2.5𝑃𝑤ℎ𝑒𝑎𝑡
Fleur: 𝑞𝑏𝑢𝑡𝑡𝑒𝑟𝑏𝑒𝑒𝑟 = −10 + 3.5𝑃𝑤ℎ𝑒𝑎𝑡
Solution? Market Demand & Supply
Solution continued
Elasticities
What does elasticity mean in “English”?
What does it mean in “Economics” terms?
The story so far:
- We have learned about utility.
- From there we get the demand for a good we desire.
- When a group of people have separate demand curves, aggregating
them gives us the market demand.
- What is left is the degree of responsiveness to change in prices and
incomes.
This degree of responsiveness is known as an
elasticity.
Very Elastic
Less Elastic
Price
Price
Quantity
Quantity
More specifically, in Ag-marketing terms...
An elasticity measures the change in quantity as
price changes.
Very Elastic
Less Elastic
Price
Price
Quantity
Quantity
Flexibility
- The exact opposite of elasticity.
Definitions:
1) Own price elasticity of demand or just the price elasticity of
demand is the measure of responsiveness of quantity demanded of
good X to a change in the price of good X.
2) Income elasticity of demand is the measure of responsiveness of
quantity demanded of good X to a change in the income.
3) Cross price elasticity of demand is the measure of responsiveness
of quantity demanded of good Y to a change in the price of good X.
Own Price Elasticity of Demand
How do you find it?
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑋 𝑃𝑋
𝑒=
×
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑋
𝑄𝑋
Own Price Elasticity of Demand
How do you find it?
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑋
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑋
∆𝑄𝑋 𝑃𝑋
𝑒=
×
∆𝑃𝑋 𝑄𝑋
response
change
On the graph…
Very Elastic
Less Elastic
Price
∆𝑃
∆𝑄
∆𝑃
∆𝑄
slope
slope
Price
Quantity
Quantity
Flexibility of good
How do you find it?
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑋
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑋
∆𝑃𝑋 𝑄𝑋
𝑒=
×
∆𝑄𝑋 𝑃𝑋
response
change
Let’s start with a simple example
Lord Voldemort is a wand enthusiast. His demand function for wands
is:
𝑄𝐿𝑉 = 60 − 0.5𝑃𝑤𝑎𝑛𝑑
Voldemort’s price elasticity of wands for the following prices and
quantities is:
1) P = 60, Q = 30
2) P = 80, Q = 20
3) P = 20, Q = 50
Recall…
- Visualize any given demand equation in the form 𝑦 = 𝑎 + 𝑏𝑥
Where,
a = intercept
b = slope of that line.
Solution?
What does this mean?
- When the price increases by 1%, Voldemort will consume x% less
wands.
Example: Flexibility
You already have Voldemort’s demand function. Find wand’s flexibility
if :
1) P = 60 and Q = 30
2) P = 80 and Q = 20
3) P = 20 and Q = 50
Solution?
What is the interpretation?
When quantity demanded of wands increased by 1%, then price of
wands will decrease by x%
A word on Point Elasticity
More intuition!
Properties of Demand Elasticities
- For normal goods demand elasticity is negative.
If e < -1, then:
- The good is price elastic.
- A 1% change in price will cause a greater than 1% change in quantity
demanded.
If -1< e <0
- Then the good is price inelastic.
- A 1% change in price will cause a less than 1% change in quantity
demanded.
Properties of Demand Elasticities
- If e = 0, price is perfectly inelastic.
Question: what must the value of e be for demand to be perfectly
elastic?
𝑒=∞
Income elasticity of Demand
-Same idea as before. Now we find, measure of responsiveness of
quantity demanded of good X to a change in the income.
$ per unit
Price
new demand
Original demand
𝑋1
𝑋2
Units of X
Income elasticity of Demand
How do you find it?
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑋
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐼𝑛𝑐𝑜𝑚𝑒
∆𝑄 𝐼
𝑒=
×
∆𝐼 𝑄
response
change
Response in quantity
Change in income
Steps that you should follow:
1) The first and the most important step: Figure out the slope of the
function.
2) Remember, the way you plot your line matters
For this graph:
price
∆𝑝𝑟𝑖𝑐𝑒
∆𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Your demand function should
be of the form.
𝑝𝑟𝑖𝑐𝑒 = 𝑎 + 𝑏 ∗ 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
quantity
Since the above line is
downward sloping “b” must be
negative.
Homework 3: Income Elasticity of Demand
Darth Sidious likes owning lightsabers. The relationship between his
quantity of lightsabers demanded and income can be given by:
𝑄𝑙𝑖𝑔ℎ𝑡𝑠𝑎𝑏𝑒𝑟 = 60 + 0.25𝐼
Let his income be $60 and Q = 61. Find his income elasticity of demand
and interpret it.
Cross Price Elasticity of Demand
- Cross price elasticity of demand is the measure of responsiveness of
quantity demanded of good Y to a change in the price of good X.
How do you find it?
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑌
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑋
∆𝑄𝑌 𝑃𝑋
𝑒=
×
∆𝑃𝑋 𝑄𝑌
Cross-Price Elasticities of Demand
If the elasticity is:
- Positive: The goods are substitutes
- Negative: The goods are complements
- Zero: The goods are independent.
More formal definitions:
- Income: a change in income can increase or decrease purchasing
power. For normal goods, an increase in income implies greater
consumption of the good.
- Substitutes: an increase in the price of another good will lead to a
greater consumption of good i : 𝑒𝑖,𝑗 > 0
- Complements: an increase in the price of another good will lead to a
lesser consumption of good i. 𝑒𝑖,𝑗 < 0
Cross-Price Elasticity of Demand Example:
- Suppose there are two brands of lightsabers in the market. The
supply relation is given by:
𝑄𝑏𝑟𝑎𝑛𝑑1 = 60 + 0.3𝑃𝑏𝑟𝑎𝑛𝑑2
What is the cross-price elasticity of demand
Elasticity of Supply
- Price Elasticity of Supply: the percentage change in quantity supplied
if there is a 1% change in price.
- Price Flexibility of Supply: the percentage change in price if there is a
1% change in quantity supplied.
Basic Idea
- As quantity increases, supply elasticity nears 1.
- As price increases, the supply curve flattens (becomes more elastic).
Think of it this way:
Higher Price  higher incentive to plant  more acres  more supply
curves included in aggregate supply.
Question:
- Consider a Wheat supplier in Oklahoma. His Supply function is given
by:
𝑄𝑤ℎ𝑒𝑎𝑡 = −10 + 15𝑤ℎ𝑒𝑎𝑡
Find the elasticity of supply?
Solution?
Let’s look at a couple of more examples:
Q1: The cross-price elasticity of beer and soda is positive. Are the two
substitutes or complements?
Q2: Agricultural Economists have estimated the following elasticities. If you
are a producer in the beef industry. Which is a more threatening competitor
for you:
1) Cross-price elasticity of demand for beef with respect to pork = -0.0781.
2) Cross-price elasticity of demand for beef with respect to poultry = -0.0417.
3) Cross-price elasticity of demand for beef with respect to fish = -0.0241.
Solution?
Remember negative cross-price elasticity
Advanced Analysis
Example: Consider the following supply function for an Oklahoma
Wheat supplier.
𝑄𝑤ℎ𝑒𝑎𝑡 = 25 + 25𝑃𝑤ℎ𝑒𝑎𝑡 − 10𝑃𝑟𝑦𝑒 − 15𝑃𝑏𝑎𝑟𝑙𝑒𝑦 − 8𝑊𝑓𝑢𝑒𝑙 + 10𝑅𝑎𝑖𝑛
Prices given as:
𝑃𝑤ℎ𝑒𝑎𝑡 = $5, 𝑃𝑟𝑦𝑒 = $5.50, 𝑃𝑏𝑎𝑟𝑙𝑒𝑦 = $5, 𝑊𝑓𝑢𝑒𝑙 = $2.50,
𝑅𝑎𝑖𝑛𝑓𝑎𝑙𝑙 = 10𝑖𝑛
Example continued: Advanced Analysis
Find:
1) Aggregate Supply of Wheat?
2) Own and Cross-price elasticities at the given values.
Solution?
Homework 4
Darth Vader is a lightsaber supplier. His supply function can be given by:
𝑄𝑙𝑠 = 1 + 3𝑃𝑙𝑏 − 4𝑃𝑙𝑎𝑠𝑒𝑟𝑏𝑙𝑎𝑠𝑡𝑒𝑟 + 7𝑃𝑓𝑢𝑒𝑙
Let 𝑃𝑙𝑏 = 1, 𝑃𝑙𝑎𝑠𝑒𝑟𝑏𝑙𝑎𝑠𝑡𝑒𝑟 = 1 and 𝑃𝑓𝑢𝑒𝑙 = 5
1) Find aggregate supply of lightsabers?
2) Find own-price and cross-price elasticities of Supply?
3) Find fuel elasticity of Supply?
Equilibrium Displacement Models (EDM)
Objective: Let’s actually calculate by how much shocks affect markets.
EDM calculations are excellent for analyzing events such as:
-
Market shocks to the supply or demand.
Government policies that affect prices.
Effects of invasive species.
Interaction of substitutes and complements.
Before Moving on: A quick review of Demand
and Supply Shifts
Single Commodity EDM Analysis
Consider a scenario, where:
1) There is a negative shock to the supply of wheat, causing the supply
curve to shift inward.
2) The resulting rise in price causes a decrease in the quantity
demanded until a new equilibrium is reached.
EDM: What we are interested in calculating
How much did the price and quantity actually change due to the shock?
That is:
1) What is the percentage change in quantity demanded (% ∆ 𝑄𝐷)?
2) What is the percentage change in quantity supplied ((% ∆ 𝑄𝑆)?
3) What is the percentage change in price (%P)?
The shock itself is exogenous. Meaning: the shock from outside the market.
For example: think of floods causing havoc in a town, with a big
manufacturing industry.
In the farming context, this could be a cattle disease, reducing supply.
Understanding what’s going on graphically.
Solving the problem
To answer the questions, we need elasticity information.
- Elasticities of supply and demand curves (𝑒𝐷 and 𝑒𝑆 ).
- The amount of the shock (shift) to the supply curve (𝑆𝑆 ).
- Once we have these we can solve for the changes in quantity
demanded and supplied, using the formulas:
% ∆ 𝑄𝐷 = 𝑒𝐷 × % ∆𝑃 + 𝑆𝐷
% ∆ 𝑄𝑠 = 𝑒𝑆 × % ∆𝑃 + 𝑆𝑆
Key to solving the problem
- When the curves shift, what is the relationship of % ∆𝑄𝐷 to % ∆𝑄𝑆 ?
- Because after the shock the market returns to an equilibrium,
The amount that quantity demanded changed by is the same as the
amount that the quantity supplied changed.
In other words, % ∆𝑄𝐷 = % ∆ 𝑄𝑆
Equating the two equations and solving we
get:
𝑒𝐷 × % ∆𝑃 + 𝑆𝐷 = 𝑒𝑆 × % ∆𝑃 + 𝑆𝑆
⇒ % ∆𝑃 =
𝑆𝐷 −𝑆𝑆
𝑒𝑆 −𝑒𝐷
Remember denominator must always be positive.
Question: EDM Analysis
Q: Suppose that due to a failure of eradication, the wheat stem sawfly
has caused a substantial reduction in Montana wheat supply. The
resulting negative shift of the supply curve causes the quantity supplied
to go down by 10%. Analyze the changes in price and quantity
demanded/supplied in the wheat market, knowing that the following
is true:
Elasticity of wheat supply (𝑒𝑆 ) = 1.5
Own-price elasticity of wheat demand (𝑒𝐷 ) = -2
Solution
Let’s do this step by step:
1)
First, you need to analyze what is happening. A drop in quantity supplied is 10% {this is
the exogenous shock} (𝑆𝑆 = 10%).
Therefore using,
% ∆ 𝑄𝑠 = 𝑒𝑆 × % ∆𝑃 + 𝑆𝑆
and
𝑆𝑠 = −10%
We get:
% ∆ 𝑄𝑠 = 1.5 × % ∆𝑃 − 10%
2) The reduction in quantity supplied will increase the prices that producers charge for
wheat and what consumers pay for wheat.
How do we determine the adjustment in prices?
Solution continued
3) We need to solve for the unknown % ∆P, which will tell us the true
price adjustment due to the supply shock.
Plug values, in this equation:
𝑒𝐷 × % ∆𝑃 + 𝑆𝐷 = 𝑒𝑆 × % ∆𝑃 + 𝑆𝑆
What did you find as % ∆P?
Solution?
3) We need to solve for the unknown % ∆P, which will tell us the true price
adjustment due to the supply shock.
Plug values, in this equation:
𝑒𝐷 × % ∆𝑃 + 𝑆𝐷 = 𝑒𝑆 × % ∆𝑃 + 𝑆𝑆
−2 × % ∆𝑃 + 0 = 1.5 × % ∆𝑃 − 10%
⇒ % ∆𝑃 = 2.86%
Solution: continued
Or just plug the values in the formula:
𝑆𝐷 − 𝑆𝑆
% ∆𝑃 =
𝑒𝑆 − 𝑒𝐷
You’ll find that:
% ∆𝑃 = 2.86%
Finally find % ∆𝑄𝐷 and % ∆𝑄𝑆?
% ∆𝑄𝐷 and % ∆𝑄𝑆
Plug found value of % ∆𝑃 in either:
% ∆𝑄𝐷 = 𝑒𝐷 × % ∆𝑃 + 𝑆𝐷
Or,
% ∆𝑄𝑆 = 𝑒𝑆 × % ∆𝑃 + 𝑆𝑆
Remember that: % ∆𝑄𝐷 = % ∆𝑄𝑆
..And the answer is:
Question for practice
- Consider the following information:
-
Elasticity of apple supply (𝑒𝑆 ) = 3
Own-price elasticity of apple demand (𝑒𝐷 ) = -2.5
Elasticity of pear supply (𝑒𝑆 ) = 5
Own-price elasticity of pear demand (𝑒𝐷 ) = -3
Question: continued
Analyze the percentage change in prices and quantities if the following
scenarios occurred:
1) A rise in the price of oranges causes the demand for apples to
increase by 15%.
Homework 5:
2) A drop in apple supplies and the resulting rise in apple prices causes
the demand for pears to increase by 5%. Assume that apples and pears
are substitute goods.
Solution?
1)
Solution?
General Equilibrium Displacement Models
- In the EDM, we consider only a partial equilibrium.
- Therefore, we only ask one question:
- How does a shock affect one market?
- Shocks in one market can affect related markets.
- Which then causes feedback effects.
GEDM
- In the HW problem we solved - apple supplies decrease, causing
apple prices to rise and the demand for pears to rise, because apples
and pears are substitute goods.
- The rise in the demand for pears will then cause a feedback effect on
the apple market.
- Higher pear demand will increase pear prices and cause some
consumers to demand more apples, in turn causing apple prices to
rise further.
GEDM
- How do we analyze this particular scenario?
- We will be analyze both the apple and pear markets.
- Determine the interaction between these two markets.
- The interaction is the cross-price elasticity.
Example:
Elasticity of apple supply (𝑒𝑆 )
Own-price elasticity of apple demand (𝑒𝐷 )
Elasticity of pear supply (𝑒𝑆 )
Own-price elasticity of pear demand (𝑒𝐷 )
3
-2.5
5
-3
Cross-price elasticity of apple demand with respect
to pear prices (𝑒𝑎𝑝𝑝𝑙𝑒,𝑝𝑒𝑎𝑟 )
0.5
Cross-price elasticity of pear demand with
respect to apple prices (𝑒𝑝𝑒𝑎𝑟,𝑎𝑝𝑝𝑙𝑒 )
0.25
Setup of the 4 markets:
% ∆𝑄𝑆𝑎𝑝𝑝𝑙𝑒𝑠 = 𝑒𝑆,𝑎𝑝𝑝𝑙𝑒𝑠 × % ∆𝑃𝑎𝑝𝑝𝑙𝑒𝑠 + 𝑆𝑆,𝑎𝑝𝑝𝑙𝑒𝑠
% ∆𝑄𝐷𝑎𝑝𝑝𝑙𝑒𝑠
= 𝑒𝐷,𝑎𝑝𝑝𝑙𝑒𝑠 × % ∆𝑃𝑎𝑝𝑝𝑙𝑒𝑠 + 𝑒𝑎𝑝𝑝𝑙𝑒,𝑝𝑒𝑎𝑟 × % ∆𝑃𝑝𝑒𝑎𝑟 + 𝑆𝐷,𝑎𝑝𝑝𝑙𝑒𝑠
% ∆𝑄𝑆𝑝𝑒𝑎𝑟𝑠 = 𝑒𝑆,𝑝𝑒𝑎𝑟𝑠 × % ∆𝑃𝑝𝑒𝑎𝑟𝑠 + 𝑆𝑆,𝑝𝑒𝑎𝑟𝑠
% ∆𝑄𝐷𝑝𝑒𝑎𝑟𝑠
= 𝑒𝐷,𝑝𝑒𝑎𝑟𝑠 × % ∆𝑃𝑝𝑒𝑎𝑟𝑠 + 𝑒𝑝𝑒𝑎𝑟,𝑎𝑝𝑝𝑙𝑒 × % ∆𝑃𝑎𝑝𝑝𝑙𝑒 + 𝑆𝐷,𝑝𝑒𝑎𝑟𝑠
Question:
- Suppose that the supple of apples decreased by 10%.
How do we solve for the changes in the price of apples (% ∆𝑃𝑎𝑝𝑝𝑙𝑒𝑠 ) and
price of pears (% ∆𝑃𝑝𝑒𝑎𝑟𝑠 )?
First, we know that in equilibrium:
% ∆𝑄𝑆𝑎𝑝𝑝𝑙𝑒𝑠 = % ∆𝑄𝐷𝑎𝑝𝑝𝑙𝑒𝑠
% ∆𝑄𝑆𝑝𝑒𝑎𝑟 = % ∆𝑄𝐷𝑝𝑒𝑎𝑟
Solve for equilibrium
- You should have two equations and two unknowns:
- Find changes in prices and quantities
% ∆𝑃𝑎𝑝𝑝𝑙𝑒𝑠 = 1.83%
% ∆𝑃𝑝𝑒𝑎𝑟𝑠 = 0.057%
% ∆𝑄𝐷𝑎𝑝𝑝𝑙𝑒𝑠 = −4.55%
% ∆𝑃𝑝𝑒𝑎𝑟𝑠 = 0.287%
Homework 6
Sugar can be produced from sugar beets grown in Montana or sugar
cane grown in Texas. These markets are linked, and so shocks to one
market must be analyzed with respect to the other market.
Homework 6: Continued
Elasticity of sugar beets supply (𝑒𝑆 )
Own-price elasticity of sugar beets demand (𝑒𝐷 )
1.2
-0.9
Elasticity of sugar cane supply (𝑒𝑆 )
1.5
Own-price elasticity of sugar cane demand (𝑒𝐷 )
-1
Cross-price elasticity of sugar beets demand with respect
to sugar cane prices (𝑒𝑏𝑒𝑒𝑡,𝑐𝑎𝑛𝑒 )
1.2
Cross-price elasticity of sugar cane demand with
respect to sugar beet prices (𝑒𝑐𝑎𝑛𝑒,𝑏𝑒𝑒𝑦 )
0.25
Setup of the 4 markets:
% ∆𝑄𝑆𝑎𝑝𝑝𝑙𝑒𝑠 = 𝑒𝑆,𝑎𝑝𝑝𝑙𝑒𝑠 × % ∆𝑃𝑎𝑝𝑝𝑙𝑒𝑠 + 𝑆𝑆,𝑎𝑝𝑝𝑙𝑒𝑠
% ∆𝑄𝐷𝑎𝑝𝑝𝑙𝑒𝑠
= 𝑒𝐷,𝑎𝑝𝑝𝑙𝑒𝑠 × % ∆𝑃𝑎𝑝𝑝𝑙𝑒𝑠 + 𝑒𝑎𝑝𝑝𝑙𝑒,𝑝𝑒𝑎𝑟 × % ∆𝑃𝑝𝑒𝑎𝑟 + 𝑆𝐷,𝑎𝑝𝑝𝑙𝑒𝑠
% ∆𝑄𝑆𝑝𝑒𝑎𝑟𝑠 = 𝑒𝑆,𝑝𝑒𝑎𝑟𝑠 × % ∆𝑃𝑝𝑒𝑎𝑟𝑠 + 𝑆𝑆,𝑝𝑒𝑎𝑟𝑠
% ∆𝑄𝐷𝑝𝑒𝑎𝑟𝑠
= 𝑒𝐷,𝑝𝑒𝑎𝑟𝑠 × % ∆𝑃𝑝𝑒𝑎𝑟𝑠 + 𝑒𝑝𝑒𝑎𝑟,𝑎𝑝𝑝𝑙𝑒 × % ∆𝑃𝑎𝑝𝑝𝑙𝑒 + 𝑆𝐷,𝑝𝑒𝑎𝑟𝑠
HW 6: Continued
- Analyze the following situations:
1) Sugar cane supply increases by 25%.
2) The FDA restricts only non Round-up Ready sugar beets to be
planted, increasing the demand for beets by 5%.
3) Prices of sugar beets fall by $5/ton from the original price of
$50/ton.
Food Marketing Channel
• An example of a steakhouse:
Some questions a consumer might have:
1) Where did the steak come from?
2) How did it get there?
3) And why is it so expensive?
Answer explained in an image
1) Calves are born and they are grass-fed until they can be sent o to
feedlots.
2) At feedlots, cattle are brought up to weight.
3) Fed cattle are processed into meat products.
4) Meat products are transported to various locations.
5) A medium-rare steak is provided to the customer.
- Each one of these steps involves a cost, which is incorporated into the final price of the
steak.
Following up from the previous chapter: suppose that customers changed their tastes and
started consuming pork.
The demand for steak would decrease causing:
1.
2.
3.
4.
5.
Decrease in the demand for meat by the Steakhouse.
Decrease in transportation of meat because less meat consumers need the product.
Decrease in how much meat is processed.
Decrease in the production (quantity supplied) of fed cattle.
Decrease in the production of feeder cattle.
That causes trigger effect on prices
- Decrease in the price that Stacey's is willing to pay for beef products.
- Decrease in how much transporters of beef receive because
consumers are less willing to pay.
- Decrease in how much feedlot operators receive.
- Decrease in how much feeder cattle producers receive.
- So where do we as Economists come in?
- So where do we as Economists come in?
- As an analyst, you may be very interested in understanding and
modeling the effects of changes in the food marketing channel.
For example, you may want to know:
- How much less you will receive for your feeder cattle if there is a BSE
outbreak that causes consumers to consume less beef.
Derived Demand
Mastering this concept: Key to understanding the rest of this chapter.
Consider the following livestock production:
Cattle  Hamburger Meat, Steaks
Chicken  Two legs, two wings, two breasts.
Soybean  Soybean meal, Soybean oil
Consumers demand the end
product
Important questions
- How do we determine the demand for the agricultural raw input
(farm level demand) product?
- In other words, what's the demand for chickens or soybeans?
- How do we determine the supply of the agricultural raw input
product?
- What are the equilibrium prices of input and final goods?
- To start answering these questions, we work backwards.
- First ask: how much of the final, processed products do consumers
demand?
- Graphs, best way to understand this:
Derived Demand: Graph
Price
𝑃𝐵
𝑃𝑆
𝐷𝐵 = 𝐷𝑆 + 𝐷𝐵
𝐷𝑆
𝑃𝐻
𝐷𝐻
Q*
Quantity
Derived Demand: Continued
- Total demand for Beef (𝐷𝐵 ) is the vertical sum of demand for steaks
(𝐷𝑆 ) and demand for Hamburgers (𝐷𝐻 ).
- For some quantity of meat Q*.
- Now that we know demand for beef.
- We are interested in understanding how this demand can be used to
derive the demand for fed cattle.
So how does fed cattle become beef?
So how does fed cattle become beef?
Through processors. That’s an entire industry itself. Therefore demand beef
(𝐷𝐵 ) can be written by:
𝐷𝐵 = 𝐷𝑓𝑒𝑑 𝑐𝑎𝑡𝑡𝑙𝑒 + 𝑆𝑃
Therefore derived demand of Fed cattle:
𝐷𝑓𝑒𝑑 𝑐𝑎𝑡𝑡𝑙𝑒 = 𝐷𝐵 − 𝑆𝑃
- The implication of the previous equation is that:
The demand for fed cattle will continue to be positive, until the
consumer market is satiated with enough processed beef.
That is until:
𝐷𝐵 − 𝑆𝑃 = 0
- If 𝐷𝐵 > 𝑆𝑃 then there is excess demand of beef and the processors will
continue to supply their services.
- If 𝐷𝐵 < 𝑆𝑃 , then the processor does not need to supply more beef.
Understanding this on the graph
Price
𝑃𝐵
𝑆𝑃
𝐷𝐵 = 𝐷𝑆 + 𝐷𝐵
Q*
𝐷𝐹𝐶 = 𝐷𝐵 − 𝑆𝑃
Quantity
Understanding this on the graph
Price
𝑃𝐵
𝑆𝑃
𝐷𝐵 = 𝐷𝑆 + 𝐷𝐻
Q*
𝐷𝐹𝐶
Quantity
- Vertical difference between 𝐷𝐵 and 𝑆𝑃 determines 𝐷𝐹𝐶 the demand
for fed cattle.
- The figure shows how demand for an agricultural commodity in this
case fed cattle, is determined by the consumers of the final goods.
- To find the equilibrium quantity and price of fed cattle (FC), look at
the supply and demand curves of fed cattle.
Equilibrium Fed Cattle
Price
𝑃𝐵
𝑆𝐹𝐶
𝑆𝑃
𝐷𝐵 = 𝐷𝑆 + 𝐷𝐵
𝑃𝐹𝐶
Q*
𝐷𝐹𝐶 = 𝐷𝐵 − 𝑆𝑃
Quantity
- You can see from the fixed proportions assumption that the quantity
of fed cattle is also the quantity of beef
Let’s look at a sample problem
- A case of BSE breaks out in the U.S. cattle market. This causes
consumers to fear that the processed meat is inedible, and the
demand for beef decreases. Analyze the following:
1) The effect on the quantity and price of fed cattle.
2) The effect on the quantity and price of beef.
3) The effect on the quantity and price of steaks and hamburgers.
Draw the graphs?
- Remember all the changes will occur in the consumer market graph
and the fed cattle graph.
Graph continued
Intuition
1) The demand for meat decreases and shifts inward.
2) Because the demand for fed cattle is derived from the from demand of
beef, the demand for fed cattle will also decrease and shift inward.
3) This will change the point at which the demand and supply curves of fed
cattle intersect. The result is a drop in quantity supplied and drop in
price.
4) Projecting the new quantity onto the new demand curve of beef, we see
that the price of beef has also decreased.
5) Projecting the new quantity onto the supply curve of P&M, we see that
the price received by fed cattle processors has decreased.
Solution: Graphs
Intuition: Continued
1) The drop in overall beef demand and quantity of beef supplied can
be illustrated by the decrease in the demands of both steak and
hamburger.
2) The demand for steak decreases. The price for steak drops.
3) The demand of hamburger decreases. The price for hamburger
drops.
Homework
Suppose the setup of the question remains the same as before. Analyse the
following scenarios:
1) The demand for steak increases.
2) The supply of processing and marketing is reduced.
3) The supply of fed cattle increases.
** Remember in this setup you are going to have three set of graphs.
Solution 1)
Solution 2)
Solution 3)
Numerical Analysis
- Everything you need to learn you have already learnt.
- The intuition remains exactly the same.
- All we do now is out numbers to the setup.
Let’s Dive right in
- Consider: you know the demand for hamburger meat and steaks, as
well as the supply of meat processing and supply of fed cattle. Derive
the demand for fed cattle. Solve for equilibrium quantity and prices
Demand Hamburger: 𝑃𝐻 = 10 − 0.5𝑄𝐻𝐷
Demand Steak: 𝑃𝑆 = 20 − 𝑄𝑆𝐷
𝑆
𝑆
Supply processors 𝑆𝑃&𝑀 : 𝑃𝑃&𝑀
= 5 + 0.5𝑄𝑃𝑀
𝑆
𝑆
Supply Fed cattle: 𝑆𝐹𝐶 : 𝑃𝐹𝐶
= −20 + 3𝑄𝐹𝐶
Solution steps
- Write down what you would need to do, step by step
Solution
Determine joint demand for beef 𝐷𝐵
Solve for derived demand for fed cattle. You know the equation.
𝐷𝐹𝐶 = 𝐷𝐵 − 𝑆𝑃&𝑀
How would you find quantities?
Use: 𝐷𝐹𝐶 = 𝑆𝐹𝐶
Plug in each equation to find prices.
Solution
Another question
So now that you know 𝐷𝐹𝐶 , find demand for feeder cattle. If the
following is given:
𝑆𝐹𝑒𝑒𝑑 : 𝑃𝐹 = −25 + 3. 𝑄
𝑆𝑓𝑒𝑒𝑑𝑒𝑟_𝑐𝑎𝑡𝑡𝑙𝑒 : 𝑃𝐹𝐶 = −4 + 𝑄
Homework 7
- Consider the market for chicken. Typically, consumers purchase chicken
wings, breasts, and legs. These parts are processed in fixed proportions each chicken yields 2 wings, 2 breasts, and 2 legs. As a poultry farmer, you
are interested in determining the demand for the raw product - chicken.
Given:
- Demand for chicken legs: 𝑃𝐿 = 5 − 0.25𝑄
- Demand for chicken legs: 𝑃𝑊 = 10 − 0.75𝑄
- Demand for chicken breasts: 𝑃𝐵 = 15 − 𝑄
- Supply for chicken P&M: 𝑃𝑀𝑃 = 8 + 0.25𝑄
- Supply for chicken: 𝑃𝐶𝑆 = −10 + 5𝑄
Solution
Solution: continued
-
Another question
Steel is a popular metal. It is used to make railway tracks and
appliances. Let 𝐷𝑆 be the demand for steel and 𝐷𝑅 and 𝐷𝐴 be the
demand for railway tracks and appliances respectively. If the supply
function of the steel processors is given by 𝑆𝑝 , find and graph the
derived demand for Iron ore (the raw material used to make steel). Also
you are given that the supply of iron ore is given by 𝑆𝐼 .
Spatial Concepts in Agricultural Markets
- Transportation is a crucial factor in agricultural marketing.
- Movement of agricultural products across geographical distances
adds value to the product.
- A decrease in transportation costs will lead to more transport and
trade.
- Location matters - placement of processing facilities is strongly
influenced by transport costs.
Factors that determine whether a commodity
should be transported?
- If the initial processing reduces weight (and transportation costs),
then processing facilities are more valuable near production sites.
- For example, flour is lighter than wheat. Beneficial to process nearby.
- If processing adds weight (and transportation costs), then processing
facilities are more valuable near end-users.
- For example, reconstituted milk is heavier than dry milk powder.
Economies of Scale
- Why aren't there many small wheat processors in Montana?
- By building a central processing plant, it may be possible to
significantly reduce total average costs.
It is about finding a
balance between
reducing transport costs
and taking advantage of
Economies-of-scale by
delivering to a central
location.
Spatial Models
1) One-dimensional models (1D model).
2) Two-dimensional models (2D model).
Important Disclaimer:
Thus far we have been talking graphs in the price and quantity space.
Now we transition into price and distance space.
Properties of 1D model
- Producers near central market will receive maximum price per unit
(transportation distance is zero).
- The price received per unit from any other location is: (Distance Cost
of Transport).
- Profitable region: any location that can receive a net price per unit
above zero.
1D Model: Two-Dimensional Net Price
Diagram
Understanding the previous graph
- Suppose that a farmer at location A can sell a commodity at the
central market.
- But, the commodity needs to transported to the central market.
- The price of transporting a commodity is constant, $c per mile.
- The farther away the farmer is from the central, the more expensive it
is to transport the commodity.
- Let 𝛿 be the distance to the central market.
- Then the total transport costs are: $𝑐 × 𝛿.
Understanding the graph: continued
- At the central market, a farmer can receive price 𝑃𝑐 .
- So, the farmer's net price is 𝑃𝑁𝑒𝑡 = 𝑃𝐶 − 𝛿 ∗ $𝑐, where 𝛿 is the distance to
the central market.
- The diagonal lines indicate the net price that a farmer will receive
depending on the location of the farm.
- The further away, farmer is from the central market, the lower the net
received price.
- Profitability region: this is the region on the graph between Location A and
Location B.
- Anywhere in that region, a farmer will have incentive to transport a
commodity to the central market because the net received price is above
or equal to zero.
Changes in the market
- There is an increase in the price paid for a commodity at the central
market.
Outcomes:
- Producers who were already in the profitable region will now receive
higher profits.
- Profitability region increases - it is now profitable for more producers
to deliver (new producers deliver).
Changes in the market
-
Consider another example:
- There is a decrease in the transportation costs of delivering a good to
the central location.
What would happen in the market? Show changes on graph?
Solution
- Outcomes:
- Producers close to the central location will not be affected.
- The slope of the net profit lines expands.
- The profitability region expands, increasing prot for current producers
and creates profit for new producers.
Graph: Lower transportation costs
Another example:
- Consider that there is a new vector of delivering a good to the central
location via a river. Producers that can ship downstream to the central
market will have much lower transportation costs than producers who
must ship upstream. Illustrate this scenario using a one-dimensional
transport model.
Overlapping Production Regions
What if there are two central markets to which delivery can occur?
Which producers choose each market?
- For two delivery locations, there may be an overlap region. It is
divided by the market boundary.
- Producers within the overlap region can deliver to either of the two
delivery locations.
- For producers in the overlap region, it is more protable to delivery
location that corresponds to their side of the market boundary.
Graphical Analysis
Homework:
Suppose that one central market exists, but it is relatively small and
pays a low price to producers. A new processing plant is built in nearby
market, and the price that this processing plant producers is
substantially higher than offered in the smaller market. Suppose that
the price offered in the new central market is so much higher that the
profitability region overlaps the entire profitability region of the small
market. What will happen to producers that delivered to the small
market? Draw graph to show
Inter-regional trade
- An important aspect of agricultural production (especially for U.S.
producers) is inter-regional trade.
- That is, moving commodities across space.
- To understand why and where commodities move, we develop a
model of supply and demand that appropriately capture relationships
between regions.
- Let's consider two regions in which there are production and
consumption of barley.
- However, in region A, the resources for producing barley are low and
the costs of production are high.
- Conversely, in region B, barley production is plentiful.
- Consequently, the price of barley in region A (𝑃𝐴 ) is substantially
higher than the price of barley in region B (𝑃𝐵 ).
- When the economy is closed (there is no trade), the prices
determined in each market are known as autarky prices.
- Prices 𝑃𝐴 and 𝑃𝐵 are autarky prices.
- Now consider that it is possible to export from one market to another
(assume that there are no transportation costs).
Key Question: Who will export and who will import?
To answer this question, you need to ask: In which market will it be
protable to buy a good, so that when you sell in the other market, you
will make a profit?
In the scenario above, 𝑃𝐵 < 𝑃𝐴
Thus, it is reasonable to purchase barley in market B and the resell the
barley in market A for a higher price.
Why does trade occur?
-
- The opportunity to profit provides incentives for producers in regions
with comparative advantage to sell to regions that are willing to pay
higher prices.
- If a producer can produce at a lower cost and sell in market that will
pay a higher price than the domestic market, than trade will occur.
Deriving the Excess Demand Curve
- Properties of Deriving Excess Demand.
- At autarky prices, no additional (excess) demand exists.
- When prices are lower than autarky prices, then:
- Domestic producers are willing to produce less (they receive a lower
price).
- Domestic consumers want to consumer more (they can buy more for a
lower
- price).
- The difference between domestic quantity demanded and domestic
quantity supplied is excess demand.
- The excess demand curve is derived from the horizontal difference
between the consumer's quantity demanded and the producer's
quantity supplied.
𝑝
𝐶
𝐸𝐷𝐴 = (𝑄𝐴 − 𝑄𝐴 )
- The amount of excess demand is the horizontal distance between the
demand and supply curves at a particular price,𝑃𝐴′ .
- At this price, the quantity that producers in the domestic market
𝑝
(market A) are willing to sell for is 𝑄𝐴 .
- The quantity that consumers wish to purchase is 𝑄𝐴𝑐 .
Deriving the Excess Supply Curve
- Properties of Deriving Excess Supply.
- At autarky prices, no additional (excess) supply exists.
- When prices are higher than autarky prices, than:
- Domestic producers are willing to produce more (they receive a higher price).
- Domestic consumers want to consumer less (they can buy less for a higher
- price).
The difference between domestic quantity supplied and domestic
quantity demanded is excess supply.
𝑝
𝐸𝐷𝐴 = (𝑄𝐵 − 𝑄𝐵𝑐 )
The excess supply curve is derived from the horizontal difference
between the producer's quantity supplied and the consumer's
quantity demanded.
Question?
Q: Suppose 𝐷𝐵 increases, show changes on both graphs. (Recalculate
Excess supply)
Q. Suppose 𝑆𝐴 increases, show changes on both graphs. (Recalculate
Excess demand)
Trade
- We need to determine the point at which trade occurs.
- We can then determine “price” at which trade occurs.
- Treat Excess demand and supply curve as regular demand and supply
curves.
- Equilibrium occurs at the point where the curves intersect.
Graphs: Trade
Graphs: Trade
Graph: Analysis
- 𝑃𝑇 is the price at which two regions trade (price received by
exporters, price paid by importers).
- 𝑄𝑇 is the quantity that is traded (quantity that is exported and
quantity that is imported).
- As regions trade, there will eventually emerge a single price for a
good that is paid /received in all regions.
- If the price is higher in a particular region, then producers will sell there {
increasing supply and decreasing price.
- If the price is lower in a particular region, then consumers will purchases
there increasing demand and increasing price.
- Trade eventually leads to a world price
Trade With Transportation Costs
- It is reasonable to assume that trade is not costless.
- The producer bears costs for transporting a commodity from one
market to another.
- The effect of transportation costs is that they make it less protable to
transfer commodities across space.
Trade With Transportation Costs
- Assume that the exporting producer adds on the cost of transporting the
good onto the price that the importing consumer must pay.
- This raises the price that the importing region must pay for the good they
receive as an export.
- Effects:
- The price at which commodities are traded is higher.
- The quantity of traded commodities is lower.
- Consumers in importing market receive less of the commodity and pay a higher
price.
- Producers in importing market sell more of the commodity and receive a higher
price.
- Consumers in exporting market receive more of the commodity but pay a lower
price.
- Producers in exporting market sell less of the commodity and receive a lower price.
When does it make sense to trade with transportation
costs:?
|𝑃𝐴 − 𝑃𝐵 | > 𝑇𝐴𝐵
- If the above relation holds then keep trading.
Homework (due Thursday
th
8
Dec)
Illustrate the effects of the following scenarios on the trade market and
the individual export and import markets using the three-diagram
model.
1. An increase in production technology in the exporting market.
2. A better than usual harvest in the importing market.
3. An increase in fuel costs, affecting the the barge and rail transport
costs.
Welfare analysis of trade: Import Market
- Determine the consumer and producer surplus at autarky prices.
- Once trade is allowed, the price in the import market will fall. This
results in two outcomes.
- The domestic producer loses some surplus, because they must sell at a lower
world price.
- The domestic consumer gains surplus from:
- The domestic producer.
- Trade.
- The final outcome is that social welfare increases by the amount of
consumer surplus gained from trade.
Graphical Analysis: Import Market
Welfare analysis of trade: Export Market
- Determine the consumer and producer surplus at autarky prices.
- Once trade is allowed, the price in the export market will rise. This
results in two outcomes.
- The domestic consumer loses some surplus, because they must incur a higher
world price.
- The producer gains surplus from:
- The domestic consumer.
- Trade.
Graphical Analysis: Export Market
Yay!! Society gains from Trade!!
International Trade
- International trade is an enormous part of U.S. agriculture.
- For example, the U.S. is one of the largest exporters of corn,
soybeans, beef, poultry, and pork.
- U.S. farmers depend heavily on exporting agricultural commodities to
other nations, because they can receive higher prices and supply a
larger quantity of the commodity.
- Thus, their total revenue is substantially increased with trade.
Politics of Trade
- International trade is a delicate issue:
- there are strong proponents for free trade and against free trade.
- Producers and consumers are heavily invested in decisions that occur
in Washington, D.C. and at the World Trade Organization (WTO).
Who wants free trade?
-
Consumers in importing countries.
Producers in exporting countries.
Governments.
Avenue for additional multinational and international corporations to
expand. Foreign direct investment.
Who doesn’t want free trade?
-
Consumers in exporting countries.
Producers in importing countries.
Politicians in large agricultural states/provinces.
Agricultural lobby groups.
Stumbling blocks to Trade
What might be some stumbling blocks that naturally / politically
prevent trade?
- Language and cultural differences.
- Transportation difficulties (e.g., getting to a trade partner through
unfriendly territory; pirates; etc.)
- Differences in government regulations - on both sides.
- Exchange rates.
Regional Trade Agreements
- NAFTA (North American Free Trade Agreement { U.S., Canada,
Mexico).
- U.S. - Australia FTA.
- CAFTA (Central America Free Trade Agreement { U.S., Costa Rica,
Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua).
- U.S. - Israel FTA.
Trade Restrictions
- Politics plays a large role in determine the level of openness
(freedom) in trade.
There are two common restrictions that many governments can use to
restrict free trade:
- Quotas: legal restriction on the quantity that can be imported.
- Tariff: a tax on an imported good. No quantity restrictions.
Quotas
- Consequences of Quotas:
- Raise prices in importing locations (who benefits? who loses?).
- Lower prices in exporting locations (who benefits? who loses?).
- Leads to a loss in total social welfare.
- Examples of Quotas in U.S.
-
Peanut Quota.
Milk / Dairy products.
Sugar.
Cotton
- Who likes quotas?
- Domestic producers { receive higher price.
- Owners of quotas / those who are allowed to import - receive higher price than if
quota did not exist.
- Foreign consumers - pay a lower price.
- Political groups who have a large incentive to maintain restricted trade.
- Who dislikes quotas?
- Domestic consumers - pay higher price.
- Potential exporters who are unable to export because they do not own a quota.
- Social welfare is reduced.
Tariffs
- Consequences of Tariffs:
- Raise prices in importing locations (who benefits? who loses?).
- Lower prices in exporting locations (who benefits? who loses?).
- Leads to a loss in total social welfare.
- Examples of Tariffs:
-
Argentinian honey : 50% - 60% tax.
Tea (from selected locations) - 6.4%.
Beef meat - 4%.
Durum wheat - $0.65/kg.