Student Guide

Basic Economics of Food Markets

One of four curriculum units for the Cargill Global Food Challenge

Student Guide

Basic Economics of Food Markets

One of four curriculum units for the Cargill Global Food Challenge Professor Curt L. Anderson Unit Author and Director Center for Economic Education University of Minnesota, Duluth

Project generously funded by Cargill CHS Foundation Center for International Food and Agricultural Policy, Univ. of Minnesota Minnesota Agricultural Education Leadership Council Minnesota Ag in the Classroom

Author: Curt L. Anderson is Professor of Economics and Director, Center for Economic Education, University of Minnesota, Duluth. He is the author of numerous economic curricula for grades K-12, including Economics and the Environment; Seas,Trees and Economies; A Yen to Trade; and Middle School World Geography: Focus on Economics (co-author). Project Director: Claudia Parliament, Professor, Department of Applied Economics, University of Minnesota, and Executive Director, Minnesota Council on Economic Education. Graphic Design: Kirsten Wedes, Minneapolis This publication was made possible through funding by Cargill. Copyright 2004, Minnesota Council on Economic Education, 1994 Buford Avenue, St. Paul, MN 55108; www.mcee.umn.edu. All rights reserved.The activities and worksheets may be duplicated for classroom use, the number not to exceed the number of students in each class.With the exception of the activities and worksheets, no part of this book may be reproduced in any form or by any means without permission in writing from the publisher. Printed in the United States of America. ISBN 0-9764093-1-3 54321

Table of Contents
INTRODUCTION 3 Provides an overview of the guide and what you will be asked to do to meet the challenges of the unit.

PART 1 PRICE DETERMINATION 4 Introduces the basic concepts of Demand and Supply and how they determine the equilibrium price of a commodity.

PART 2 UNDERSTANDING DEMAND 8 Explains why buyers react to prices the way they do and looks at factors that can change the Demand for a commodity.

PART 3 UNDERSTANDING SUPPLY 14 Explains why sellers react to prices the way they do and looks at factors that can change the Supply of a commodity.

PART 4 PRICE CHANGES 20 Shows how changes in Demand and Supply lead to changes in the equilibrium price of a commodity.

GLOSSARY 25 Defines the key economic concepts discussed in Parts 1-4.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

This unit challenges you to learn the basic economic principles that determine the price of goods and the amount of them that is produced. It then challenges you to apply your knowledge to a food commodity of your choice.

Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

WHAT DO YOU NEED TO DO TO MEET THE CHALLENGE?

The Full Challenge is described below. However, your teacher can use this unit in several different ways and may choose for you to complete only selected parts of the elements listed. Be sure you listen carefully to his/her instructions!

Finally, complete a project report to demonstrate that you have completed all the Challenge Tasks.

1 2 3
Second, complete the three Challenge Tasks that are listed at the end of each Part.

First, choose a general food commodity that you would like to study.

This could be an agricultural commodity, such as corn, beans, wheat, rice, coffee, potatoes, peanuts, lettuce, some other vegetable (tomato, broccoli, peas, etc.), apples, or some other fruit (bananas, oranges, grapes, etc.).You might also choose a livestock or animal commodity, such as beef, pork bellies, chicken, mutton, shrimp, tuna, or other fresh fish.You may also choose general processed foods like milk, sugar, or cheese.What is important is that you choose a general (or generic) commodity as opposed to a specific branded good, and that the commodity is ultimately part of something people eat or drink for pleasure or nourishment. The first task in each Part is to complete an Activity which demonstrates your understanding of the economic concepts presented in that Part.The remaining two tasks have you apply these concepts to the commodity you have chosen.You will be asked to do such things as find price and other data about your commodity, describe how your commodity is produced, develop an advertising strategy for your commodity, and analyze a specific change in the price of your commodity. This report should consist of five items: (1) A cover page with your name, your teachers name, your school, and the date (2) The four completed Activity sheets (one from each Part) (3) A written response to each of the eight other tasks (two in each Part) (4) Supplementary material (charts, tables, graphs, schematics, pictures, etc.) (5) A list of resources you used.

Dont be afraid to be creative in your responses and supplementary materials!

Make copies of each of the Activities before completing them. Each of your written responses should be limited to one page (not including supplementary materials).The supplementary materials should directly support your written responses. (Do not include materials not addressed in your responses.) In your list of resources, include people you talked to or received letters from (name, date, affiliation),Web addresses of Internet sites, and books, magazines or other publications you read and/or took excerpts from (title, author, publication date).

Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

PART 1 PRICE DETERMINATION

You have probably heard it all your lifeprice is all a matter of Supply and Demand. But what does that mean? It means you probably need to know something about Supply and Demand.
Supply shows the different quantities of a commodity that sellers would offer for sale at various prices.

Supply and Demand

The Supply of a commodity is not just one amount, like 100 apples.That might be the quantity that is supplied at a price of $1.00 per apple, but at a price of $2.00 per apple, producers would likely want to produce and sell even more apples. Supply shows the different quantities of a commodity that sellers would offer for sale at various prices. Generally we would expect that, as the price gets higher, the quantity sellers would offer for sale would also get larger.This relationship is shown in Figure 1 as Supply. Note that prices are listed along the vertical axis, while amounts of the commodity (here, apples) are shown along the horizontal axis. If the price is $1.00 per apple, you find the quantity that would be supplied by reading over to Supply, then down to the horizontal axis.The quantity supplied would be 400 apples. Similarly, if the price were $1.60, 700 apples would be supplied. The Demand for a commodity is not just one amount, like 100 apples.That might be the quantity that would be bought at a price of $1.00 per apple, but at a price of $2.00 per apple, people would likely buy fewer apples. Demand shows the different quantities of a commodity that buyers would purchase at various prices. Generally we would expect that, as the price gets higher, the quantity that buyers would purchase would get smaller.This is often called the law of demand.This relationship is shown in Figure 1 as Demand. Starting again at a price of $1.00 per apple and reading over to Demand and then down, you find a quantity of 600 apples would be demanded. However, if the price were $1.60, only 300 units would be demanded. Supply and Demand show how sellers and buyers respectively react to different prices. Sellers react to higher prices by supplying larger quantities, while buyers react to higher prices by demanding smaller quantities. So, which price does the market settle on? Where Supply and Demand cross on the graph is an obvious choiceand the correct one, but why is this so?

Demand shows the different quantities of a commodity that buyers would purchase at various prices.

Market Equilibrium
In the apple market shown in Figure 1, Supply and Demand cross at a price of $1.20.This means that if the price were $1.20, the quantity supplied by sellers (500 apples) would be exactly the same as the quantity

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

demanded by buyers (also 500 apples).Thus, all buyers who wish to purchase apples at this price are able to do so, and all sellers who wish to sell apples at this price are also able to do so.This is called the market equilibrium point, because neither the buyers nor the sellers have any reason to change anything. The equilibrium price in the market would be $1.20, while 500 units would be the equilibrium quantity. Now consider what would happen if the price were not $1.20.

Part 1
Figure 1: Market Equilibrium
Price per Apple
$2.00

Price Determination

Supply

$1.60

$1.20 $1.00

Market Equilibrium

Demand

At prices greater than the equilibrium $0.40 price, the quantity of apples supplied would exceed the quantity demanded. For example, 0 100 300 400 500 600 700 900 at a price of $1.60, 700 apples would be Quantity of Apples offered for sale, but only 300 apples would be purchased at this price.This would result in a surplus of apples in the market. At a price of $1.60, the surplus would be 400 apples (700300).This means that some sellers would not be able to find buyers for the apples they produced.This creates an incentive for sellers to offer to sell at a lower price to induce buyers to buy from them.Thus, the price of a commodity tends to be bid down toward its equilibrium level when there is a surplus. At prices less than the equilibrium price, the quantity of apples demanded would exceed the quantity supplied. For example, at a price of $1.00, 600 apples would be demanded, but only 400 apples would be offered for sale.This would result in a shortage of apples. At a price of $1.00, the shortage would be 200 units (600400).This means that some of the buyers who are willing and able to buy at this price will not be able to get an apple.This creates an incentive for buyers to offer to pay a higher price to induce sellers to sell to them.Thus, the price of a commodity tends to be bid up toward its equilibrium level when there is a shortage. So, the market price of a commodity is indeed a matter of Supply and Demand. The price of a commodity is either at or heading toward the equilibrium price. The equilibrium price may be described in three different but equivalent ways. The equilibrium price is that price at which: Supply crosses (or intersects) Demand. The quantity supplied by sellers equals the quantity demanded by buyers. There is neither a surplus nor a shortage of the commodity in the market. A final note of caution: The description of price determination given above depends on markets being competitive.This is true whenever there are enough buyers and sellers, so that no single buyer or seller is able to affect the market price on their own.This tends to be the case in the world markets for basic food commodities.
Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Market equilibrium occurs when neither buyers nor sellers have any reason to change anything.

The price of a commodity tends to be bid up toward its equilibrium level when there is a shortage.

The price of a commodity tends to be bid down toward its equilibrium level when there is a surplus.

Part 1
Price Determination

Challenge Tasks
A. Complete Activity 1. B. Find price data about your commodity. Present this data with graphs and/or tables and summarize it in a written report.This data may include any or all of the following: Current price per unit (include how units are measured for your commodity) Historical and/or recent trends in the price Regional variations in the price across the United States and/or world Other relevant or noteworthy price information. A helpful Web site is the U. S. Bureau of Labor Statistics (www.bls.gov/data). Look under Prices and Living Conditions for Average Price Data. Another site is the U.S. Department of Agriculture (www.usda.gov). Look under Marketing and Trade for Pricing. C. Find production/consumption (quantity) data about your commodity. Present this information with graphs and/or tables and summarize it in a written report. This data may include any or all of the following: Current quantity sold per unit of time (daily, weekly, monthly, or yearly) Amount of your commodity that was sold in the United States and/or world in recent years Amount of your commodity that the United States imports or exports each year Amount of your commodity the average consumer consumes in a year Other relevant or noteworthy quantity information. Useful sources for this information are the U.S. Department of Agriculture and any of the many commodity organizations, such as the National Pork Board, the Corn Growers Association, etc.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

ACTIVITY 1
Price per pound
$14 $12 $10 $8 $6 $4 $2 0 1 2 3 4 5 6 7 8

Part 1
Price Determination

D S

Consider the diagram to the right in answering the questions below.

Quantity of pork bellies (1000s of pounds)

1. What is the quantity demanded by buyers and quantity supplied by sellers at each of the prices below? Quantity Demanded __________________ __________________ __________________ __________________ __________________ Quantity Supplied ________________ ________________ ________________ ________________ ________________

$12 $10 $8 $6 $4

2. What is the equilibrium price and quantity in this market? $_________ per pound; _________ pounds of pork bellies Given this price and quantity, what would be the total amount of money earned by the pork belly sellers? $ _________ (This is called total revenues or total sales.) 3. Give an example of a price that would result in a surplus. $_________ per pound What is the amount of the surplus at this price? _________ pounds of pork bellies 4. Describe what would happen in the market if the price were $4 per pound, and discuss how this would likely affect the price.

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PART 2 UNDERSTANDING DEMAND

Value
Suppose you were asked how much you were willing and able to pay to have an apple a day to eat. Perhaps you say $1.00, because you like apples and have enough money to afford that. One of your friends, who likes apples as much as you do but has even more money to spend, might say more than $1.00.Yet another of your friends, who does not like apples much, might say something less than $1.00maybe even nothing. How much a person is willing and able to pay for something (that is, how much they think it is worth to them) is called the value of the commodity to that person. Clearly this depends on how well the commodity satisfies a persons wants. Since people have different wants and tastes (some get a lot of satisfaction from apples, some get a little, some dont get any at all) and different financial circumstances (some are rich, some are poor, some are in between), peoples values are different. Imagine that we asked ten people what they are each willing and able to pay for an apple per day, ranked these values from highest to lowest, and then graphed the result.The ranking and graph might look something like that shown in Figure 2. As you would expect, there is a range of values (here, from a high of $2.00 to a low of $0.20). Given these values, how would this group respond to different apple prices? For example, suppose the price of an apple were $1.40. Looking at the chart, we see four people (Jesse, Kim, Maria, and Kyle) who are willing and able to pay $1.40 or more for an apple. It makes sense for each of them to buy an apple.They gain more value from the apple than the $1.40 they must give up to buy it.The other six people, who each value an apple at less than $1.40, would not want to buy an apple at this priceit just isnt worth that much to them.

How much a person is willing and able to pay for something (that is, how much they think it is worth to them) is called the value of the commodity to that person.

In deciding whether or not to buy a commodity, people compare the value they get from it (how much they are willing and able to pay for it) to the price of the commodity (how much they actually have to pay to get it). If their value is greater than or equal to the price, they buy it. If not, they dont.

Figure 2: Value of Apples

Apple
$2.00

Buyer
Jesse Kim Maria

Value
$2.00 $1.80 $1.60 $1.40 $1.20 $1.00 $0.80 $0.60 $0.40 $0.20

Value
$1.40

Price of $1.40

Kyle Mindy

$0.80

Clark Jill

$0.20 0 1 4 7 10

Erik Molly

Apples

Ryan

Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

This information can be seen by looking at the graph (Figure 2). If a horizontal line is drawn at a price of $1.40, you see that it intersects the Value line at a quantity of four apples. It is easy to see that the first four apples are valued at $1.40 or more (the Value line is above the Price line), while the next six apples are valued at less than $1.40 (the Value line is below the Price line). Both the chart and the graph make a very simple point: In deciding whether or not to buy a commodity, people compare the value they get from it (how much they are willing and able to pay for it) to the price of the commodity (how much they actually have to pay to get it). If their Figure 3: Shifts in Demand value is greater than or equal to the price, they buy it. Price If not, they dont. Now suppose the price of an apple were $0.80. At this price, seven apples would be purchased. Do you agree? At this lower price, there are more people with values P* that are greater than or equal to the price, so more apples are purchased. At this lower price, it is now Decrease in worthwhile for three more people (Mindy, Clark, and Demand Jill) to buy an apple. So, what does all this have to do with Demand? Quite simply, the Value line shown in 0 Quantity Figure 2 is the Demand for apples! Remember that Demand shows how much buyers would purchase at different prices, which is exactly what this line does.Thus, the Demand for a commodity is fundamentally based on peoples values (that is, what they feel the commodity is worth to them).
Increase in Demand

Part 2
Understanding Demand
Thus, the Demand for a commodity is fundamentally based on peoples values (that is, what they feel the commodity is worth to them).

Increases and decreases in Demand

The Demand (Value line) shown in Figure 2 was based on just two things: (1) the number of people or buyers in the market and (2) how much each person values the commodity (that is, what each person is individually willing and able to pay for the commodity or, in other words, what they feel it is worth to them). Thus, only a change in one or both of these can alter the position of Demand. If Demand shifts to the right (see Figure 3), more of the commodity would be purchased at each and every price (check this by looking at the quantities demanded at a price of P*).This would be an increase in Demand. If Demand moved to the left, less of the commodity would be bought at each and every price.This would be a decrease in Demand. Let us see how changes in the two factors above can lead to these shifts in Demand.

A change in the number of buyers in the market

Suppose that, instead of looking at the values of ten people, we had considered the values of twenty people. Suppose further that these other ten

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Part 2
Understanding Demand

people had the same values as the first ten (that is, one of them valued an apple at $2.00, another valued it at $1.80, and so on).Then, at each and every price, twice as many apples would be purchased as were before. Demand would have increased. If there had been a hundred times as many people with similar values, one hundred times as many apples would have been purchased at each price.This is in fact the Demand shown in Figure 1 of Part 1! Conversely, if there had been fewer buyers in the market, Demand would have been further to the left. The number of buyers in a market could change as a result of population changes due to growth or migration. It could also change as a result of changes in buyers access to the market. As transportation systems have developed, it has become easier to move commodities to where potential buyers are, thus allowing them the opportunity to buy the commodity. Access to markets, however, could be reduced by such things as trade barriers or other government restrictions.

A change in buyers values

If a commodity becomes more valuable to people, this causes the value line to rise vertically. But since this line is also Demand, more of the commodity would be purchased at each and every price.Thus, an increase in buyers values leads to an increase in Demand. Conversely, a decrease in buyers values leads to a decrease in Demand.What might cause buyers values (what buyers are willing and able to pay for a commodity) to change? A change in buyers tastes or preferences As people start desiring a commodity more, they will become more willing to buy it. Conversely, if a commodity no longer satisfies a want they have, they will value it less highly. Peoples tastes and preferences are constantly changing due to new information they receive, influences of those around them, successful advertising campaigns, or simply by growing older. (As you age, you might find eating spicy foods less pleasurable because your body reacts differently to them.) If the commodity is used to produce some other good (such as wheat to produce bread or potatoes to produce French fries), then an increase (decrease) in the value of the produced good would lead to an increase (decrease) in the value of the commodity used to produce it. A change in buyers income and/or wealth As peoples income or wealth increases, they become more able to buy commodities. For most goods,

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

one would expect that, as people have more money to spend, they will value commodities more highly. But with some commodities (called inferior goods), people may actually value them less as their income rises. For example, college students might buy a lot of macaroni and cheese while they are in school, but once they get their first job and have more money, they might actually decrease their purchases of macaroni and cheese. A change in the price of other goods Often, how much people value a commodity depends on the price of related goods. Suppose two commodities are reasonably good substitutes for each other, that is, either of them could be used to satisfy some want. Take butter and margarine as an example. As the price of margarine rises, it makes butter a relatively more desirable way to satisfy ones want for something to spread on toast. Conversely, as the price of margarine falls, it makes butter relatively less attractive.Thus, for substitutes, a change in the price of one of them leads to a change in the value of the other in the same direction.Two commodities might instead be complements for each other, meaning they tend to be used together to satisfy a want.Take ice cream and chocolate syrup as an example. As the price of ice cream rises, people buy less ice cream and, therefore, not value chocolate syrup as much. As the price of ice cream falls, people buy more of it and, therefore, value chocolate syrup more.Thus, for complements, a change in the price of one of them leads to a change in the value of the other in the opposite direction. A change in expectations If you expect the price of some good to rise in the future, that might cause you to value getting more of it today (increase your current Demand). If you expect that you might lose your job in the future, due to layoffs at the company where you work, that might cause you to value commodities less highly and to value saving your money for the future more highly. To summarize, the Demand for a commodity increases (shifts to the right) whenever the number of buyers increases or the value of the commodity to buyers increases. The Demand for a commodity decreases (shifts to the left) whenever the number of buyers decreases or the value of the commodity to buyers decreases.

Part 2
Understanding Demand
For substitutes, a change in the price of one of them leads to a change in the value of the other in the same direction. For complements, a change in the price of one of them leads to a change in the value of the other in the opposite direction.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Part 2
Understanding Demand

Challenge Tasks
A.Complete Activity 2. B. Suppose you are in charge of increasing Demand for your commodity through advertising.Write a recommendation to the trade association of producers of your commodity addressing the following points: Who buys your commodity and why do they buy it? On what characteristics of your commodity should the advertising campaign focus? What other commodities are reasonable substitutes (competitors!) for your commodity? Create an original tag line for your commodity based on your answers to the above questions (such as Got milk? or BeefIts whats for dinner C. Describe the route your commodity takes from its production to its final consumption.This may include any or all of the following: Where it is produced How it is transported, stored, used to produce other goods, and delivered to final consumers A schematic of the various steps A breakdown of how your commodity is ultimately used (for example, what percent is sold directly to final consumers, what percent is sold to various intermediate users, etc.).

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ACTIVITY 2
1. Suppose the price of some commodity is $5 per unit. Explain why some people might call this a great deal while others might say it is a rip-off.

Part 2
Understanding Demand

2. Each line below has a world commodity market and an event. In Column 1 you are to determine what kind of change is occurring in the market as a result of this event. Circle the number which best describes what is changing, using the following codes: 1 Change in the number of buyers 2 Change in buyers values: Change in buyers tastes 3 Change in buyers values: Change in buyers income/wealth 4 Change in buyers values: Change in the price of other goods 5 Change in buyers values: Change in expectations In Column 2, circle whether this change is an increase or decrease in the number of buyers or in buyers values and finally, in Column 3, circle whether this will shift Demand to the left (L) or to the right (R). 1 KIND OF CHANGE 12345 12345 12345 12345 2 INCREASE OR DECREASE 3 DEMAND SHIFT L R L R L R L R

MARKET milk wheat potato sugar

EVENT The price of cereal rises. A new carbohydrate-free diet sweeps the world. Several countries ban the importation of potatoes. Political unrest in some sugar-exporting countries threatens future supplies. A recession hits several developed nations. Cases of mad cow disease are reported. The price of coffee rises. Income tax rates are lowered in the U.S. World population rises.

cocoa beef tea shrimp soybean

12345 12345 12345 12345 12345

L R L R L R L R L R

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

PART 3 UNDERSTANDING SUPPLY

Cost
You saw in Part 2 that Demand fundamentally depends on what buyers think a commodity is worth to them (that is, how much they value it). Here you will see that Supply fundamentally depends on the costs to sellers of producing the commodity and making it available for sale. To produce any commodity requires the use of resources such as land, raw materials, energy, workers, equipment, and buildings. For example, growing corn takes land, seeds, fertilizer, water, farmers, farm equipment, and silos. Producers must pay for these resources. The payments to use these resources are the cost to the producer of producing the commodity. Producers, however, do not all have the same costs. Some producers may have more modern equipment and technology and/or more productive workers.This would make their cost per unit of output less than for other producers. Some farmers may have more productive soil or better weather conditions. Again, this would make their cost per unit of output less. Some producers may manage their resources very carefully, while others do not.Those that dont would have higher cost per unit of output. Imagine that we took ten producers (A through J) who were interested in providing apples, ranked their cost of providing apples from lowest to highest, and then graphed the result.The ranking and graph might look something like that shown in Figure 4. As we might expect, there is a range in costs (here, they run from a low of $0.40 to a high of $2.20). Figure 4: Cost to Produce Apples
Producer $/apple
$2.20 F C E $1.60

In deciding whether or not to produce a commodity and offer it for sale, producers compare the cost of producing it to the price they will get for it. If their cost is less than or equal to the price, they will produce and offer it for sale. If not, they wont.

Cost
$0.40 $0.60 $0.80 $1.00 $1.20 $1.40 $1.60 $1.80 $2.00 $2.20

Cost

I A J

$0.80

Price of $0.80
$0.40 0 1 3 7 10

D H G

14

Apples

Given these costs, how would this group respond to different apple prices? For example, suppose the price of an apple were $0.80. Looking at the chart, we see three producers (F, C, and E) who have costs less than or equal to this price. It makes sense for each of them to produce and sell an apple.They gain $0.80 from selling the apple, and it costs

Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

them less than or equal to that amount to produce it.The other seven producers have costs higher than $0.80. Each of them would lose money by selling apples at this price. This same information can be gained by looking at the graph. If a horizontal line is drawn at a price of $0.80, you see that it intersects the Cost line at a quantity of three apples. It is easy to see that the first three apples cost less than or equal to $0.80 (the Cost line is below the Price line), while the next seven apples cost more than $0.80 to produce (the Cost line is above the Price line). Both the chart and the graph make a very simple point: In deciding whether or not to produce a commodity and offer it for sale, producers compare the cost of producing it to the price they will get for it. If their cost is less than or equal to the price, they will produce and offer it for sale. If not, they wont. Now suppose the price of an apple were $1.60. At this price, seven apples would be supplied. Do you agree? At this higher price, there are more producers with costs that are now less than or equal to the price, so more apples would be produced and offered for sale. At this higher price, it is now profitable for four more apples to be produced. Given this, we see something similar to what we saw about Demand.The Cost line is the Supply of apples. Remember that Supply shows how much sellers would offer for sale at different prices, exactly what the line is telling us.Thus, the Supply of a commodity is fundamentally based on the costs of producing it.

Part 3
Understanding Supply

Thus, the Supply of a commodity is fundamentally based on the costs of producing it.

Increases and decreases in Supply

The Supply (Cost line) shown in Figure 4 was based on just two things: (1) the number of producers (sellers) in the market and (2) how much it costs each seller to produce the commodity.Thus, only a change in one or both of these can alter Supply. If Supply shifts to the right (see Figure 5), more of the commodity would be produced and Figure 5: Shifts in Supply offered for sale at each and every Price price. (Check this by looking at the quantities supplied at a price of P*.) This would be an increase in Supply. Decrease in If Supply moves to the left, less of the Supply commodity would be produced and offered for sale at each price.This P* would be a decrease in Supply. Let us see Increase in how changes in the two factors above can Supply lead to these shifts in Supply.
0

Quantity

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Part 3
Understanding Supply

A change in the number of sellers

Suppose that, instead of looking at the costs of just ten producers, we had considered the costs of twenty different sellers. Suppose further that these additional ten sellers had the same costs as the first ten (that is, one of them had a cost of $0.40, the next a cost of $0.60, and so on). If this had been the case, twice as many apples would have been offered for sale at each price. Supply would have increased or shifted to the right. If there had been a hundred times as many sellers with similar costs, one hundred times as many apples would have been offered for sale at each price (this is in fact the Supply shown in Figure 1 of Part 1!). Conversely, if there had been fewer producers, Supply would have been further to the left. The number of sellers in a market depends on how easy it is for sellers to start or shut down a business producing the commodity. If markets are competitive, this is very easy. The number of sellers will change along with the profitably of producing the commodity: sellers added when profits are good and sellers lost when losses are occurring. However, financial or technological barriers may exist which make it difficult for new sellers to sell in a market. Similarly, trade barriers may keep sellers from being able to sell their commodities in foreign countries.

How much of the commodity a given amount of resources is able to produce is called their prodictivity. Thus, higher productivity leads to lower costs, while lower productivity leads to higher costs.

A change in sellers costs

If a commodity becomes more costly to produce, the cost line will rise vertically. But since this line is also Supplyless of the commodity would be purchased at each and every price. Thus, an increase in the cost of producing a commodity leads to a decrease in Supply. Similarly, a decrease in the cost of producing a commodity leads to an increase in Supply. What might cause a change in costs? A change in the productivity of the resources used to produce the commodity Resources are needed to produce any commodity. How much of the commodity a given amount of resources is able to produce is called their productivity. Suppose one worker can produce ten units of some commodity in a day, and she is paid $60 for this. In terms of worker time required, each unit of this commodity costs $6 to produce ($60/10). Now suppose the worker figures out a better way to do her job and is able to produce 12 units each day. Not only is the worker more productive, but the cost of each unit falls to $5 ($60/12).Thus, higher productivity leads to lower costs, while lower productivity leads to higher costs.The productivity of workers can increase from better training and education. The productivity of machines is often increased with advances in new technologies. New discoveries in seeds, fertilizers, and hormones can also increase the production of crops and livestock.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

A change in the prices of resources Costs are payments for the resources used to produce a commodity. If the amount of resources used and their productivity stay the same, but their prices rise, then the cost to produce the commodity must also rise. Conversely, if resource prices fall, the cost of producing the commodity will also fall.Thus, it is important to understand what resources are used in producing a commodity and in what direction the resource prices are moving in order to analyze how costs might be changing. A change in government policies The government may increase the cost of producing a commodity by requiring producers to meet certain safety, health, or environmental standards, which typically require that producers use more resources. The government might also place taxes on the sale of certain commodities.The government can reduce the cost of producing commodities by subsidizing their production (paying part of the costs) or by reducing regulations or required paperwork. A change in expectations How much of a commodity sellers offer for sale today may depend on their expectations for the future. Producers may produce a commodity today but hold it in storage (not offer it for sale) if they believe the price in the future might be higher. Essentially, the cost of selling the commodity today is higher because of the lost opportunity to sell it for more in the future. Producers might also produce and offer to sell more today because they believe the prices of the resources they use may be higher in the future. So, relative to the future, costs are lower today. To summarize, the Supply of a commodity increases (shifts to the right) whenever more sellers come into the market or the costs to produce the commodity fall. The Supply of a commodity decreases (shifts to the left) whenever sellers leave the market or the costs to produce the commodity rise.

Part 3
Understanding Supply

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Part 3
Understanding Supply

Challenge Tasks
A Complete Activity 3. B. Describe how your commodity is produced. Include in this description any or all of following: A list of the resources that are required and the role each of them plays in the production process A schematic of how it is processed and/or pictures of it being grown or harvested A description of the methods used to grow and harvest your commodity and where exactly this occurs Cost data related to the production of your commodity Names of some of the major producers of your commodity. C. Describe any government involvement in the production and/or selling of your commodity. This might include such things as: Names of federal or state agencies in the U.S. that are involved and their role Subsidies, special tax breaks on equipment, taxes, etc. Required health standards Environmental regulations Trade restrictions.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

ACTIVITY 3
1. Most production processes are subject to the law of diminishing returns. Basically this means that the productivity of resources used in production tends to fall as more is produced.What would this imply about the cost of producing additional units?

Part 3
Understanding Supply

2. Each line below has a world commodity market and an event. In Column 1 you are to determine what kind of change is occurring in the market as a result of this event. Circle the number which best describes what is changing, using the following codes: 1 Change in the number of sellers 2 Change in sellers costs: Change in productivity 3 Change in sellers costs: Change in the price of resources 4 Change in sellers costs: Change in government policies 5 Change in sellers costs: Change in expectations In Column 2, circle whether this change is an increase or decrease in the number of sellers or in sellers costs, and, finally, in Column 3, circle whether this will shift Supply to the left (L) or to the right (R). 2 3 1 INCREASE OR SUPPLY KIND OF EVENT MARKET DECREASE SHIFT CHANGE

rice hog corn chicken cherry oats cheese lettuce tuna

A faster-growing variety of rice is developed. Stricter odor controls are imposed on hog feedlots. A major drought occurs. The price of chicken feed falls.

12345 12345 12345 12345

L R L R L R L R L R L R L R L R L R

Losses lead producers to 12345 turn orchards to other uses. Special tax breaks are given on farm equipment. Milk prices are expected to rise in two months. The price of irrigation water increases. 12345 12345 12345

A new detection system 12345 makes tuna easier to locate.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

PART 4 PRICE CHANGES

You have seen in Part 1 that the equilibrium price in a market depends on Supply and Demand. But you have also seen in Parts 2 and 3 that Supply and Demand can change. Each can increase or decrease. If either happens, this changes the market equilibrium point. In fact, changes in Supply or Demand are the only things that can cause the market equilibrium point to change. Obviously, it will move to the new point where Supply and Demand intersect, and the equilibrium price will change accordingly.While this is simple enough, it is helpful to break this down into three steps.

Analyzing Market Changes

Begin by assuming some market in equilibrium. Now suppose that some event occurs which might have an impact on this market. Step 1: Determine if the event is affecting buyers values, sellers costs, or the number of buyers or sellers in the market. This determines whether Demand or Supply has changed. This is the most important step to consider carefully.The various factors that affect buyers values were discussed in Part 2 (changes in tastes, income, prices of other goods, and expectations). If any of these has been affected or if the number of buyers in the market has changed, then Demand has changed.The various factors that affect sellers costs were discussed in Part 3 (changes in productivity, the prices of resources, government policy, and expectations). If any of these has been affected or if the number of sellers in the market has changed, then Supply has changed. Step 2: Determine in which direction (increase or decrease) Demand or Supply has changed. If buyers values or the number of buyers have increased (decreased), then Demand has increased (decreased). If sellers costs have increased (decreased), then Supply has decreased (increased). If the number of sellers has increased (decreased), then Supply has increased (decreased). Notice that you have to be a bit careful when things are changing on the supply side. Remember that an increase in either Demand or Supply means a shift to the right, while a decrease in either means a shift to the left. Step 3: Determine the new market equilibrium point. This occurs at the point where the new Demand crosses the old Supply if Demand has changed, or where the old Demand crosses the new

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Supply if Supply has changed. In any case, the equilibrium price will be higher or lower than it was before. The following example will illustrate this process. Suppose the market shown in Figure 6 is the market for lobsters, and that it is in equilibrium at a price of $12 per lobster and a quantity of 100 lobsters per day. Now suppose that headlines are reporting that the economy is really starting to grow, unemployment is falling, and peoples incomes are rising. How might this affect the lobster market? Lets go through the steps to analyze this question. Figure 6: A Change in the Price of Lobsters
Price of Lobsters

Part 4
Price Changes

Supply

$14 $12

New Demand

Demand

Step 1: Since incomes are rising and Quantity of Lobsters more people have jobs, more people are able to pay more for all commodities, including lobsters.Thus, there is an increase in the value of lobsters to buyers. Step 2: An increase in the value of lobsters to buyers means an increase in the Demand for lobsters.This would be shown as a rightward shift of Demand as shown in Figure 6. Step 3: The new market equilibrium would be the point at which the old Supply crosses the new Demand.This results in a price of $14 and a quantity of 120 lobsters. Notice that at the old price of $12, the quantity supplied would be less than the new quantity demanded.This creates a shortage, which is what causes the price to rise from $12 to $14. Thus, the impact of an improving economy on the lobster market is likely to mean higher lobster prices and more lobsters produced. Be sure to go through these steps in the order presented above when analyzing the impact of some event on a market. Dont try to skip to the answer, even though it seems obvious. If two or more events are occurring, it is possible that both Demand and Supply may be changing at the same time. If this is the case, the method described above still provides the best way to analyze these changes. Analyze each event separately to see what the expected impacts on the equilibrium price and quantity are. If all events are expected to move the equilibrium price (or quantity) in the same direction, then clearly it would move in that direction. However, if one event would result in a lower equilibrium price (or quantity) and another in a higher equilibrium price (or quantity), then the result of both events is ambiguousit will depend on which resulting shift is larger.

100

120

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Part 4
Price Changes

For example, suppose in the example above that pollution flowing into the oceans is killing lobsters. Clearly, this event alone would result in a decrease in Supply and lead to a higher equilibrium price and lowered equilibrium quantity.Thus, combined with the first event (rising incomes, which led to a higher equilibrium price and higher equilibrium quantity), it is clear that the impact of both events will be a higher equilibrium price, however, the equilibrium quantity could either fall, rise, or stay the same, depending on which event led to a larger change in quantity.

Secondary Effects
You have seen how an event can affect the market and equilibrium price of a commodity.This is called the primary effect. However, what happens to the price in one market can have secondary effects in other markets. For example, suppose you heard that a new fertilizer was dramatically improving wheat production. Going through the steps above, you might logically conclude that this would lead to a decrease in the price of wheat. This is the primary effect. But that is not the end of the story. A decrease in the price of wheat is itself an event that will likely affect other markets. A decrease in the price of wheat, which is used in producing bread, would likely lead to a decrease in the price of bread.This, in turn, is an event which might lead to an increase in the price of butter, a complement of bread.These are secondary effects.Thus, while you might say the price of butter is rising due to falling prices for bread, the actual reason it is rising goes all the way back to the use of the new fertilizer. Understanding how markets are connected to each other is thus very important in understanding price movements.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Part 4
Price Changes

Challenge Tasks
A. Complete Activity 4. B. Find a newspaper, magazine, or online article that describes or discusses a change in the price of your commodity.Then do the following: Describe this change in your own words, using the terminology and models you have learned in this Unit Include a Supply-Demand graph (properly labeled) showing this change Describe any secondary effects you expect as a result of this change in the price of your commodity. C. Make a projection of what the price of your commodity will likely do over the coming year and also over the next ten years.What factors do you think will put upward pressure on the price? Explain.What factors do you think will put downward pressure on the price? Explain.

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

Part 4
Price Changes

ACTIVITY 4
1. Shown below are the four graphs (A through D) that represent the four possible cases that can result from a Demand or Supply shift. Given the events below, circle the letter which best represents what would be happening in the primary market indicated, as well as the secondary impacts in the other markets listed. GRAPH A
S Price S1 Price

GRAPH B
S1 S

D Quantity Quantity

GRAPH C
S Price Price

GRAPH D
S

D1 D Quantity

D D1 Quantity

EVENT A pest infestation kills a large number of orange trees. A new machine lowers the cost of harvesting potatoes. Due to good profits, many farms are converted from other uses to hog production. Drinking hot chocolate becomes a worldwide fad.

PRIMARY MARKET Orange A B C D Potatoes A B C D Hog A B C D

OTHER MARKETS Orange juice A B C D French fries A B C D Chicken A B C D Grapefruit A B C D Ketchup A B C D Chicken feed A B C D

Hot chocolate A B C D

Cocoa A B C D

Chocolate bars A B C D

2. Suppose events were happening that increased both the Demand and Supply of a commodity. Explain how this could lead to a rise, a fall, or no change in the equilibrium price of the commodity.What would happen to the equilibrium quantity?

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Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

GLOSSARY
Complements Two commodities that are used together to satisfy a want. Cost The amount of money a producer must pay for the resources used in production. A relationship that shows the quantity of a commodity that buyers are willing and able to buy at various prices. The price in a market at which the quantity demanded by buyers equals the quantity supplied by sellers. The quantity that is both demanded and supplied at the equilibrium price in a market. A group of buyers and sellers interested in exchanging some commodity. The point at which Supply intersects Demand.

Demand

Equilibrium Price Equilibrium Quantity Market Market Equilibrium Price Productivity Resources

The amount of money one must pay in exchange for a commodity. The amount of output per unit of resource input. The human (workers), capital (equipment, tools), and natural (land, raw materials) inputs used to produce commodities. A market situation where the quantity demanded is greater than the quantity supplied (caused by a price in the market that is below the equilibrium price). Two commodities, either of which could satisfy a given want. A relationship that shows the quantity of a commodity that sellers are willing and able to sell at various prices. A market situation in which the quantity supplied is greater than the quantity demanded (caused by a price in the market that is above the equilibrium price).

Shortage

Substitutes Supply

Surplus

Value The amount of money a buyer is willing and able to pay for a commodity (which is, in turn, based on how well the commodity satisfies a want or desire the buyer has).

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MN Council on Economic Education Department of Applied Economics University of Minnesota St. Paul, MN 55108

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