basic economics of food market

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Basic Economicsof Food Markets

StudentGuide

One of four curriculum units

for the Cargill Global Food Challenge


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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

Student Guide

One of four curriculum units for the Cargill Global Food Challenge

Basic Economicsof Food Markets


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ISBN 0-9764093-1-3 54321

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 andEconomies;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 ExecutiveDirector, 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 andworksheets may be duplicated for classroom use, the number not to exceed thenumber 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 withoutpermission in writing from the publisher. Printed in the United States of America.


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1Basic Economics of Food Markets, Minnesota Council on Economic Education, St. Paul, MN

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 changethe 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 20Shows 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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1

2

3

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!

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 impor-

tant is that you choose a general (or generic) commodity as opposed to a

specific branded good, and that the commodity is ultimately part ofsomething 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.

Make copies of each of the Activities before completing them. Each of your writtenresponses 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).

First, choose

a general food

commodity

that you would

like to study.

Second,

complete

the three

Challenge

Tasks that are

listed at the

end of each

Part.

Finally,

complete a

project report

to demonstrate

that you have

completed all

the Challenge

Tasks.

Dont beafraid tobe creativein yourresponses andsupplementamaterials!


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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 and DemandThe 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.Thequantity 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

choice and the correct one, but why is this so?

Market EquilibriumIn 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

Supply showsthe different

quantities of acommodity that

sellers wouldoffer for sale atvarious prices.

Demandshows thedifferent

quantities ofa commodity

that buyerswould

purchase at

various prices.


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5

Part 1Price

Determination

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.

At prices greater than the equilibrium

price, the quantity of apples supplied would

exceed the quantity demanded. For example,

at a price of $1.60, 700 apples would be

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 (700 300).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 (600 400).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.

Marketequilibriumoccurs whenneither buyersnor sellers havany reasonto changeanything.

The price of acommoditytends to be bidup toward itsequilibrium

level when theis a shortage.

The price ofa commoditytends to bebid downtoward itsequilibriumlevel when theis a surplus.

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.

Supply

MarketEquilibrium

Demand

Quantity of Apples

Priceper

Apple

$2.00

$1.60

$1.20

$1.00

$0.40

0 100 300 400 500 600 700 900

Figure 1: Market Equilibrium


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6

Part 1Price

Determination


Challenge Tasks

A. Complete Activity 1.

B. Find price data about your commodity. Present this data with graphs and/ortables 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 andany of the many commodity organizations, such as the National Pork Board,

the Corn Growers Association, etc.


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7

Part 1Price

Determination


ACTIVITY 1

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 discusshow this would likely affect the price.

0

$2

$4

$8

$10

$12

$14

$6

1 2 3 4 5 6 7 8

Price perpound

Quantity of pork bellies(1000s of pounds)

DS

Considerthe diagram

to the right in

answering the

questions below.


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PART 2 UNDERSTANDING DEMAND

ValueSuppose 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 mucha person is

willing and ableto pay for

something (thatis, how much

they think it isworth to them)

is called thevalue of the

commodity to

that person.

In decidingwhether

or not to buya commodity,

people comparethe value they

get from it (howmuch they are

willing and ableto pay for it) tothe price of the

commodity(how much theyactually have to

pay to get it).If their value is

greater thanor equal to the

price, they buy it.If not, they dont.

0

$0.20

$1.40

$2.00

$0.80

1 4 7 10

Apple

Apples

Value

Price of $1.40

Buyer Value

Jesse $2.00

Kim $1.80

Maria $1.60

Kyle $1.40

Mindy $1.20

Clark $1.00

Jill $0.80

Erik $0.60

Molly $0.40

Ryan $0.20

Figure 2: Value of Apples


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Part 2Understanding

Demand

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

value is greater than or equal to the price, they buy it.

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

that are greater than or equal to the price, so more

apples are purchased.At this lower price, it is now

worthwhile for three more people (Mindy, Clark, and

Jill) to buy an apple. So, what does all this have to do

with Demand? Quite simply, the Value line shown in

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).

Increases and decreases in DemandThe 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 ussee how changes in the two factors above can lead to these

shifts in Demand.

A change in the number of buyers in the marketSuppose that, instead of looking at the values of ten people, we had

considered the values of twenty people. Suppose further that these other ten

Thus, theDemand for acommodity isfundamentalbased on peo-ples values(that is, whatthey feel thecommodity isworth to them

0

P*

Price

Quantity

Decrease inDemand

Increase inDemand

Figure 3: Shifts in Demand


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Part 2Understanding

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 valuesIf 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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Part 2Understanding

Demand

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 goodsOften, 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, there-

fore, 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 buyersincreases 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.

For substitutesa changein the priceof one of themleads to a chain the valueof the otherin the samedirection.

For complemena changein the priceof one of themleads to a cha

in the valueof the otherin the oppositedirection.


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12

Part 2Understanding

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.

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).

milk The price of cereal rises. 1 2 3 4 5 L R

wheat A new carbohydrate-free 1 2 3 4 5 L Rdiet sweeps the world.

potato Several countries ban the 1 2 3 4 5 L Rimportation of potatoes.

sugar Political unrest in some 1 2 3 4 5 L Rsugar-exporting countriesthreatens future supplies.

cocoa A recession hits several 1 2 3 4 5 L Rdeveloped nations.

beef Cases of mad cow 1 2 3 4 5 L Rdisease are reported.

tea The price of coffee rises. 1 2 3 4 5 L R

shrimp Income tax rates are 1 2 3 4 5 L Rlowered in the U.S.

soybean World population rises. 1 2 3 4 5 L R 13

Part 2Understanding

Demand

MARKET EVENT

1

KIND OF

CHANGE

2

INCREASE OR

DECREASE

3

DEMAND

SHIFT



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PART 3 UNDERSTANDING SUPPLY

CostYou 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 makingit 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. Somefarmers 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 likethat 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).

Given these costs, how

would this group

respond to different

apple prices? For exam-

ple, 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 costs0

$0.40

$1.60

$2.20

$0.80

1 3 7 10

$/apple

Apples

Cost

Price of $0.80

14

In decidingwhether or not

to produce acommodity andoffer it for sale,

producerscompare the cost

of producing itto the price they

will get for it.If their cost is

less than orequal to the

price, they willproduce and

offer it for sale. Ifnot, they wont.

Producer Cost

F $0.40

C $0.60

E $0.80

I $1.00

A $1.20

J $1.40

B $1.60

D $1.80

H $2.00

G $2.20

Figure 4: Cost to Produce Apples



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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. Atthis 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.

Increases and decreases in SupplyThe 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

offered for sale at each and every

price. (Check this by looking at the

quantities supplied at a price of P*.)

This would be an increase in Supply.

If Supply moves to the left, less of the

commodity would be produced andoffered for sale at each price.This

would be a decrease in Supply. Let us see

how changes in the two factors above can

lead to these shifts in Supply.

0

P*

Price

Quantity

Decrease inSupply

Increase inSupply

Thus, the Suppof a commodifundamentallbased on the cof producing i

15

Part 3Understanding

Supply


Figure 5: Shifts in Supply


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16

Part 3Understanding

Supply

A change in the number of sellersSuppose 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 beenoffered 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.

A change in sellers costsIf 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 ofworker time required, each unit of this com-

modity 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.

How much of the

commodity agiven amount ofresources is able

to produceis called their

prodictivity.

Thus, higherproductivity

leads tolower costs,while lower

productivityleads to

higher costs.



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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 ofcertain 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.

17

Part 3Understanding

Supply



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18

Part 3Understanding

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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19

Part 3Understanding

Supply

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?

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 sellers2 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).

rice A faster-growing variety 1 2 3 4 5 L Rof rice is developed.

hog Stricter odor controls are 1 2 3 4 5 L Rimposed on hog feedlots.

corn A major drought occurs. 1 2 3 4 5 L R

chicken The price of chicken 1 2 3 4 5 L Rfeed falls.

cherry Losses lead producers to 1 2 3 4 5 L Rturn orchards to other uses.

oats Special tax breaks are 1 2 3 4 5 L Rgiven on farm equipment.

cheese Milk prices are expected 1 2 3 4 5 L Rto rise in two months.

lettuce The price of irrigation 1 2 3 4 5 L Rwater increases.

tuna A new detection system 1 2 3 4 5 L Rmakes tuna easier to locate.

MARKET EVENT

1

KIND OF

CHANGE

2

INCREASE OR

DECREASE

3

SUPPLY

SHIFT



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20

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 theonly

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 ChangesBegin 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 orSupply 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 orSupply 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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Supply

New Demand

Demand

Quantity of Lobsters

Price ofLobsters

$14

$12

0 120100

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 priceof $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.

Step 1: Since incomes are rising and

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 thebest 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.

Figure 6: A Change in the Price of Lobsters

21

Part 4Price Changes



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22

Part 4Price 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 EffectsYou 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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23

Part 4Price 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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24

Part 4Price 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.

A pest infestation kills a Orange Orange juice Grapefruitlarge number of orange A B C D A B C D A B C Dtrees.

A new machine lowers Potatoes French fries Ketchupthe cost of harvesting A B C D A B C D A B C Dpotatoes.

Due to good profits, Hog Chicken Chicken feedmany farms are converted A B C D A B C D A B C Dfrom other uses to hogproduction.

Drinking hot chocolate Hot chocolate Cocoa Chocolate barsbecomes a worldwide fad. A B C D A B C D A B C D

2. Suppose events were happening that increased both the Demand and Supply ofa 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?

PRIMARY

MARKETEVENT

OTHER

MARKETS

Price

Quantity

S

D

S1

Price

Quantity

S

D

S1

Price

Quantity

S

D

D1 Pric

e

Quantity

D

S

D1

GRAPH A GRAPH B

GRAPH C GRAPH D



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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 inproduction.

Demand A relationship that shows the quantity of a commodity that buyers arewilling and able to buy at various prices.

Equilibrium The price in a market at which the quantity demanded by buyers equalsPrice the quantity supplied by sellers.

Equilibrium The quantity that is both demanded and supplied at the equilibrium priceQuantity in a market.

Market A group of buyers and sellers interested in exchanging some commodity.

Market The point at which Supply intersects Demand.Equilibrium

Price The amount of money one must pay in exchange for a commodity.

Productivity The amount of output per unit of resource input.

Resources The human (workers), capital (equipment, tools), and natural (land, rawmaterials) inputs used to produce commodities.

Shortage A market situation where the quantity demanded is greater than thequantity supplied (caused by a price in the market that is below the

equilibrium price).

Substitutes Two commodities, either of which could satisfy a given want.

Supply A relationship that shows the quantity of a commodity that sellers are willing

and able to sell at various prices.

Surplus A market situation in which the quantity supplied is greater than the quantitydemanded (caused by a price in the market that is above the equilibrium price).

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

basic economics of food market

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