2014 Essay Question 2

Question

In 2012 the UK had very poor harvests for grain and potatoes, which are major ingredients of many of the foods of UK consumers and also provide feed for much of Britain’s livestock. At the same time there was a decline in the real incomes of many UK citizens, especially those on low incomes.

Using economic analysis, discuss the impact these events are likely to have had on UK consumers and farmers. [25]

Answer

Demand and Price Elasticity of Supply (grain and potatoes)

As the income elasticity of demand for food is positive, which means that it is a normal good, a fall in the real incomes of UK citizens especially those on low incomes will lead to a decrease in the demand. This is particularly true in view of the relatively high income elasticity of demand for food of low income individuals. As grain and potatoes are major ingredients of many of the foods of UK consumers, a decrease in the demand for food will lead to a decrease in the demand for grain and potatoes. When this happens, the price and the quantity will fall which will lead to a decrease in the consumer expenditure and the farmers’ revenue. When the demand for grain and potatoes falls, whether the price effect or the quantity effect on the consumer expenditure and the farmers’ revenue will be greater will depend on the price elasticity of supply. The supply of grain and potatoes is likely to be price inelastic as the production time is long due to the long gestation period and they cannot be stocked due to the perishable nature. Therefore, the price is likely to fall by a larger proportion than the quantity and hence the price effect on the consumer expenditure and the farmers’ revenue is likely to be greater than the quantity effect. Students need to draw a diagram showing a leftward shift in the demand curve and shade the area which represents the consumer expenditure and the farmers’ revenue before and after the shift.

Supply and Price Elasticity of Demand (grain and potatoes)

Poor harvests for grain and potatoes will lead to a decrease in the supply. When the supply of grain and potatoes falls, the price will rise and the quantity will fall. Although the increase in the price will increase the consumer expenditure and the farmers’ revenue, the decrease in the quantity will decrease the consumer expenditure and the farmers’ revenue. When the supply of grain and potatoes falls, whether the consumer expenditure and the farmers’ revenue will rise or fall will depend on the price elasticity of demand. The demand for grain and potatoes is likely to be price inelastic due to the high degree of necessity and lack of close substitutes. Therefore, the price is likely to rise by a larger proportion than the fall in the quantity and hence the consumer expenditure and the farmers’ income is likely to rise. Students need to draw a diagram showing a leftward shift in the supply curve and shade the area which represents the consumer expenditure and the farmers’ revenue before and after the shift.

Combined Effects

Although the decrease in the demand for grain and potatoes will lead to a decrease in the consumer expenditure and the farmers’ revenue, the decrease in the supply is likely to lead to an increase in the consumer expenditure and the farmers’ revenue as the demand is likely to be price inelastic. The decrease in the demand and the decrease in the supply will both lead to a fall in the quantity. Although the decrease in the demand will lead to a fall in the price, the decrease in the supply will lead to a rise in the rise. Students need to consider the relative changes in the demand and the supply to determine the effect on the price and hence the effect on the consumer expenditure and the farmers’ revenue.

As the YED for food is low as food is a necessity,  a fall in the real incomes of UK citizens is likely to lead to a small decrease in the demand resulting in a small decrease in the demand for grain and potatoes. Furthermore, as the harvests for grain and potatoes are very poor, the decrease in the supply is likely to be large. Therefore, the decrease in the supply is likely to be greater than the decrease in the demand. If this happens, the price will rise. Although the rise in the price will increase the consumer expenditure and the farmers’ revenue, the fall in the quantity will decrease the consumer expenditure and the farmers’ revenue. However, as the decrease in the demand and the decrease in the supply will both lead to a fall in the quantity, and the fall in the price which occurs due to the decrease in demand will partially offset the rise in the price which occurs to the decrease in the supply, the proportionate decrease in the quantity is likely to be greater than the proportion increase in the price. Therefore, the consumer expenditure and the farmers’ revenue are likely to fall. Students need to draw a diagram showing a simultaneous shift in the demand and the supply curves and shade the areas which represent the consumer expenditure and the farmers’ revenue before and after the shifts.

Demand and Price Elasticity of Supply (beef and cattle)

As a fall in the real incomes of UK citizens will lead to a decrease in the demand for food, the demand for beef will fall. When this happens, the price and the quantity will fall which will lead to a decrease in the consumer expenditure. A decrease in the demand for beef will lead to a decrease in the demand for cattle resulting in a fall in the farmers’ revenue. As the supply of cattle is likely to be price inelastic due to the long rearing time and hence the long production time, the price is likely to fall by a larger proportion than the quantity and hence the price effect on the farmers’ revenue is likely to be greater than the quantity effect. As the supply of cattle is likely to be price inelastic, the supply of beef is likely to be price inelastic. Therefore, the price effect on the consumer expenditure is likely to be greater than the quantity effect.

Supply and Price Elasticity of Demand (beef and cattle)

A rise in the price of grain and potatoes due to poor harvests will lead to a rise in the cost of feeding cattle which will lead to a decrease in the supply of cattle. When this happens, the price will rise and the quantity will fall. Although the increase in the price will increase the farmers’ revenue, the decrease in the quantity will decrease the farmers’ revenue. A rise in the price of cattle will lead to an increase in the cost of production of beef. When this happens, the supply of beef will fall which will lead to an increase in the price and a decrease in the quantity. Although the increase in the price will increase the consumer expenditure, the decrease in the quantity will decrease the consumer expenditure. The demand for beef is likely to be price elastic due to the large number of substitutes such as chicken meat, duck meat and fish meat. Therefore, the quantity is likely to fall by a larger proportion than the rise in the price and hence the consumer expenditure is likely to fall. As the demand for beef is likely to be price elastic, the demand for cattle is likely to be price elastic. Therefore, the farmers’ revenue is likely to fall.

Combined Effects

The decrease in the supply of beef is likely to lead to a decrease in the consumer expenditure as the demand is likely to be price elastic and the decrease in the demand will lead to a decrease in the consumer expenditure. Therefore, the consumer expenditure is likely to fall. Similarly, the farmers’ revenue from the sale of cattle is likely to fall. The decrease in the consumer expenditure and the farmers’ revenue will be larger the greater the decrease in the demand, the greater the decrease in the supply and the more price elastic the demand. The decrease in the demand will be greater the higher the income elasticity of demand for food. As the income elasticity of demand for food is low,  the decrease in the demand for beef and cattle is likely to be small. The decrease in the supply will be greater the larger the rise in the price of grain and potatoes. As the rise in the price of grain and potatoes is likely to be large due to the large decrease in the supply and the price inelastic demand, the decrease in the supply of cattle and beef is likely to be large. The demand will be more price elastic the large the number of substitutes. Students need to draw a diagram showing a simultaneous shift in the demand and the supply curves and shade the areas which represent the consumer expenditure and the farmers’ revenue before and after the shifts.

Other Goods

A fall in the real incomes of UK citizens will also affect the demand for other goods depending on the YED. Students should discuss the effect of a fall in the real incomes of UK citizens on a normal good such as air travel and an inferior good such as public transport.

Air Travel (Normal Good)

When consumers’ income falls, whether the demand for a good will rise or fall will depend on the income elasticity of demand. As the income elasticity of demand for air travel is positive, which means that it is a normal good, a fall in the real incomes of UK citizens will lead to a decrease in the demand. When this happens, the price and the quantity will fall which will lead to a decrease in the consumer expenditure. The supply of air travel is likely to be price inelastic as the production time of airplanes is likely to be long and airplanes cannot be stocked in large quantities due to their large sizes. Therefore, the price is likely to fall by a larger proportion than the quantity and hence the price effect on the consumer expenditure is likely to be greater than the quantity effect.

Public Transport (Inferior Good)

As the income elasticity of demand for public transport is negative, which means that it is an inferior good, a fall in the real incomes of UK citizens will lead to an increase in the demand. When this happens, the price and the quantity will rise which will lead to an increase in the consumer expenditure. The supply of public transport is likely to be price inelastic as the production time of buses and trains is likely to be long and buses and trains cannot be stocked in large quantities due to their large sizes. Therefore, the price is likely to rise by a larger proportion than the quantity and hence the price effect on the consumer expenditure is likely to be greater than the quantity effect.

Evaluation

The evaluation will be discussed in class.

A more elaborate answer to 2014 Essay Question 2 will be provided in the economics tuition class.

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