Three Applications Of Supply Oemani And Elasticity

Can good news for farming be bad news for farmers? Why did OPt'C fail to keep the price of oil high? Does drug interdiction increase or decrease drug-related crime? At first, these questions might seem to have little in common. Yet all three questions arc about markets, and all markets are subject to the forces of supply and demand. Here we apply the versatile tools of supply, demand, and elasticity to answer these seemingly complex questions.

Can Goon News for Farming Be Bad News for Farmers?

Imagine yourself a» a Kansas wheat farmer. Because you earn all your income from selling wheat, you devote much effort to making your land as productive as possible. You monitor weather and soil conditions, check your fields for pests and disease, and study the latest advances in farm technology. You know that the more wheat you grow, the more you will have to sell after the harvest, and the higher will be your income and your standard of living.

One day. Kansas Stale University announces a major discovery. Researchers in its agronomy department have devised a new hybrid of wheat that raises the amount farmers can produce from each acre of land by 20 percent. How should you react to this news? Does this discovery make you better off or worse off than you were before?

Recall from Chapter 4 that we answer such questions in three steps. First, we examine whether the supply or demand curve shifts. Second, we consider in which direction the curve shifts. Third, we use the supply-and-demand diagram to see how the market equilibrium changes.

In this case, the discovery of the new hybrid affects the supply curve. Because the hybrid increases the amount of wheat that can be produced on each acre of land, farmers are now willing to supply more wheat at any given price. In other words, the supply curve shift* to the right. The demand curve remains the same because consumers' desire to buy wheat products at any given price is not affected by the introduction of a new hybrid. Figure 7 shows an example of such a change. When the supply curve shifts from s, to s2, the quantity of wheat sold increases from 100 to 1 111, and the price of wheat falls from S3 to $2.

Docs »his discovery make farmers better off? As a first cut to answering this question, consider what happens to the total revenue received by farmers. Farmers' total revenue is P X Q, the price of the wheat time» the quantity sold. The discovery affects farmers in two conflicting ways. The hybrid allows farmers to produce more wheat (Q rises), but now each bushel of wheat sells for less IP falls).

Whether total revenue rises or falls depends on the elasticity of demand. In practice, the demand for basic foodstuffs such as wheat is usually inelastic because these items are relatively inexpensive and have few good substitutes- When the demand curve is inelastic, as it is in Figure 7, a decrease in price causes total revenue to fall. You can see this in the figure: The price of wheal falls substantially, whereas the quantity of wheat sold rises only slightly. Total revenue falls from to $220. Thus, the discovery of the new hybrid lowers the total revenue that farmers receive from the sale of their crops.

If farmers are made worse off by the discovery of this new hybrid, one might wonder why they adopt it. The answer goes to the heart of how competitive markets work. Because each farmer is only a small part of the market for wheat, he or she takes the price of wheat as given. For any given price of wheat, it is better to use the new hybrid to produce and sell more wheat. Yet when all farmers do this, the supply of wheat increases, the price falls, and fanners arc worse off.

Although this example may at first seem hypothetical, it helps to explain a major change in the US. economy over the past century. Two hundred years ago, most Americans lived on farms. Knowledge about farm methods was sufficiently primitive that most Americans had to be farmers to produce enough f<xxi to feed the nation's populatkm. Yet over time, advances in farm technology increased the amount of food that each farmer could produce. This increase in food supply, together with inelastic food demand, caused farm revenues to fall, which in turn encouragixl people to leave farming.

A few numbers show the magnitude of this historic change. As recently as 1950, there were 10 million people working on farms in the United States, representing 17 percent of the labor force. Today, fewer than 3 million people work on farms, or 2 percent of the labor force. This change coincided with tremendous advances in farm productivity: Despite the 70 percent drop in the number of farmers, US. farms now produce more than twice the output of crops and livestock that they dkl in 1950.



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