BEO2264 Microeconomic Analysis Assignment
Read the attached article and answer the following questions (You may wish to do additional research to answer some of the questions):
Question 1: Use a supply and demand model to explain the impact of the recent drought in Australia has had on the market for feed grains. (100 words, 2 marks)
The recent drought in Australia causes a decrease in supply for grain feeds because there will be low production of the products. As a result, demand will be higher than supply of the feed grain. This drives up the prices in the market for grain feeds. Increased prices of the product will then cause a decrease in demand because under the supply and demand model, increase in prices causes the decrease in demand and a decrease in prices causes an increase in demand. There will also be an increased competition for feed grains; hence causing an increase in their prices. As a result, the demand of such products will increase even as supply decreases due to reduction in inputs in terms of rain. And other natural causes due to the drought.
Supply function = P = a + bQ; Demand function = P = a – bQ
Question 2: What impact does the federal government’s subsidy of 38 cents per litre on ethanol production have on the market for ethanol in Australia? Will the producers of ethanol necessarily be 38 cents per litre better off because of the subsidy? (200 words, 4 marks)
The Federal government’s subsidy of 38 cents per litre of ethanol production increases the supply of ethanol and reduces its prices by reducing the cost of production. The producers will not necessarily be 38 cents per litre better off due to the subsidy. They may be more or less 38 cents better off, depending on the effectiveness of the producers’ marketing strategies and pricing models.
A subsidy causes a decrease in the in the price of inputs; hence causing a movement along the demand curves of such inputs towards the right. This increases demand of the inputs. This leads to increased production of ethanol due to increased inputs. Decrease in input prices also leads to a decrease in costs of production, causing ethanol producers to reduce their prices in order to reflect the reduction in production costs. This helps ethanol firms to get more customers and gain competitive advantage. The increase in customers for ethanol will occur because reduced prices of ethanol products will result in the movement along the demand curve of ethanol products, causing an increase in their demand.
In summary, subsidies cause reduction in prices of inputs and their demand increases. It also causes an increase in supply and demand of ethanol products.
Question 3: Ethanol or alcohol is a substitute fuel for petrol, and it has been added to petrol supplies by some retailers. What might have motivated the government to grant a subsidy to ethanol producers? In your opinion, does the subsidy have any economic merit? (200 words, 4 marks)
Because ethanol is a substitute fuel for petrol, the government might have subsidized ethanol production in order to encourage its consumption and reduce the consumption of petrol which is not economical and environmentally unfriendly. People are motivated to substitute one product for another if the prices of the substitute are lower than the prices of the other product (Pindyck and Rubinfeld 143). For instance, if the prices of ethanol are lowered, people will substitute petrol with ethanol as a source of fuel. However, if the supply of ethanol is low, substitution may not be sufficient to meet the demand of fuel.
By subsidizing ethanol, the government will cause an increase in the supply of ethanol and decrease their prices (Reisman 87). Increased supply and decreased prices will then motivate fuel consumers to substitute petrol for ethanol.
While this is a green strategy to encourage the consumption of renewable energy, it is also hurtful to some sectors of the economy, namely the petrol sector. The economic merit of the subsidy depends on whether increased consumption of ethanol will cause more economic benefits or more economic losses in the petrol industry. In my opinion, I think ethanol has double merits for the economy – energy saving and increased profits in the ethanol industry.
Question 4: Using an economic model that includes both a typical firm/farm operating in a perfectly competitive market and market supply and demand curves, explain what will happen to the equilibrium price for feed grain and profits of firms/farms in the short run and in the long run. (200 words, 5 marks).
For a firm operating in a perfectly competitive feed grain market a decrease in the supply of feed grain will lead to a decrease in prices in the long run. This is because the supply model shows that an increase in prices causes a decrease in supply and vice versa as shown below. The equilibrium price will remain the same because the demand in the short run will not change. The profits in the short run will therefore decrease because there will be a decrease in supply.
Supply function = P = a + bQ
In the long run, supply of feed grain will shift from S1 to S2. To maintain equilibrium, the demand curve will shift from D1 to D2, causing an increase in prices from P1 to P2. The equilibrium prices of feed grain for the farm will therefore shift upwards. Profits in the long run will therefore increase because decrease in supply will be compensated by an equal increase in prices.
Question 5: Using an economic model that includes both a typical firm/farm in a perfectly competitive market and market supply and demand curves, explain what will happen to the equilibrium price for pork and economic profits of firms/farms in the short run and in the long run. (200 words, 5 marks).
As shown earlier, the supply and demand functions are given as: Supply function = P = a + bQ; Demand function = P = a – bQ. In this case, when the prices of feed grain go up, the costs of production will increase and the supply of Pork will decrease (Besanko et al 23). This will lead to a decrease in prices of Pork in the short run. This will cause an increase in demand in the short run.
In the long run, increased demand will cause an increase in prices of Pork. The supply curve will then shift from S1 to S2. Therefore, the quantity demanded of Pork meat decrease and the supply will also decrease in the long run. This will lead to an increase in the equilibrium price of Pork from P1 to P2. In the short run, the profits of the firm will decrease. In the long run, the profits of the firm will be two-fold; the decrease in supply of pork will cause a decrease in profits while the increase in prices will increase profits. The overall impact on profits will therefore depend on overall the magnitude of change in both supply and prices.
Besanko, David, Ronald R Braeutigam and Michael Gibbs. Microeconomics. Hoboken, NJ: John Wiley. 2011. Print.
Pindyck, Robert S and Daniel L Rubinfeld. Microeconomics. Upper Saddle River: Pearson Prentice Hall. 2005. Print.
Reisman, David A. The Institutional Economy: Demand and Supply. Cheltenham, UK: Edward Elgar. 2002. Print.