Instructor's Manual 1
Chapter 4
Competitive Markets and Agriculture
What's in This Chapter and Why
This chapter further develops demand and supply analysis. The demand curve is interpreted as giving both the quantity demanded for a given price and the demand price for a given quantity. The latter is the maximum price that a consumer will pay for one more unit, stating the idea of consumer surplus and efficiency analysis.
The supply curve is interpreted as giving both the quantity supplied for a given price and the supply price for a given quantity. The latter is the minimum price a producer would accept in return for one more unit, stating the idea of producer surplus. By presenting the supply curve as a curve of minimum acceptable prices, we can more easily interpret it as the industry marginal cost curve. Supply conditions are developed for a competitive industry without the necessity of a thorough development of the theory of the firm. Both the demand and supply curves as longrun curves are developed. In a onesemester issues course, some concepts must be sacrificed. We believe that the theory of the firm and the distinction between short and longrun supply are concepts that can be de-emphasized. In Chapters 4 and 5, however, some of the important distinctions between short and longrun analysis are introduced.
The traditional analysis of changes in demand and supply compared with changes in quantity demanded and supplied is followed by an analysis of equilibrium price and quantity. The terms excess supply and excess demand are used rather than surplus and shortage so that the student avoids confusion between surplus meaning excess supply and other meanings of surplus. All of the demand and supply examples are discussed in the context of agriculture.
The rest of the chapter discusses agriculture programs. The purpose of agriculture programs is discussed in the context of market analysis. The student is invited to consider whether agriculture programs are designed to achieve the conventional goals of reducing farm poverty and saving the family farm. Rentseeking is presented as an alternative explanation for the existence of agriculture programs.
Although we believe that agriculture and agriculture policy provide an excellent vehicle for introducing demand, supply, and policy analysis, other vehicles may come more naturally to some students. If the instructor wishes, this unit could stop at the section entitled "U. S. Agriculture."
Instructional Objectives
After completing this chapter, your students should know:
1. The distinction between a change in demand and a change in quantity demanded, and three factors that cause the demand curve to change.
2. The distinction between a change in supply and a change in quantity supplied, and three factors that cause the supply curve to change.
3. The effect of changes in demand and supply on equilibrium price and quantity exchanged.
Instructor's Manual 1
4. The avowed purpose and the actual effects of U.S. agriculture programs.
5. The types of risks faced by farms and some ways to deal with these risks.
6. The effects of and distinctions among price support programs, target price programs, and output constraint programs.
7. The concepts of economic and political rentseeking and their importance.
Key Terms
These terms are introduced in this chapter:
Instructor's Manual 1
Coefficient of the price elasticity of demand
Price elastic
Price inelastic
Unit elastic
Instructor's Manual 45
Suggestions for Teaching
This is a key chapter in the book. A careful development of demand and supply prepares the student for moving quickly through other parts of the book. In developing the material, we start with arithmetic and tabular approaches, and build to a graphical approach as we progress through the chapter and the book; however, we gradually wean the student from the former approaches and use the graphical approach exclusively.
The discussion of agriculture policy can be enlivened by using current stories from such sources as Business Week, the Economist, and The Wall Street Journal. Some instructors may want to use the discussion of the relationship between agriculture policies and trade barriers to emphasize the interdependence of national economies.
Additional References
In addition to the references in the text, instructors may wish to read or assign one or more of the following:
1. Browne, William P., Jerry R. Skees, Louis E. Swanson, Paul B. Thompson, and Laurian J. Unnevehr. Sacred Cows and Hot Potatoes: Agrarian Myths in Agricultural Policy. Boulder, CO: Westview Press, 1992.
2. Cletus C. Coughlin and Kenneth C. Carraro, "The Dubious Success of Export Subsidies for Wheat," Federal Reserve Bank of St. Louis, Review 70 (November/December 1988), pp. 3847.
3. Mark Drabenstott and Alan D. Barkema," U.S. Agriculture Charts a New Course for the l990s," Federal Reserve Bank of Kansas City, Economic Review (January/February 1990), pp. 3249.
4. Bruce Gardner, ed., U.S. Agricultural Policy: The 1985 Farm Legislation (Washington, D.C.: American Enterprise Institute for Public Policy Research, 1985).
5. Public Agenda Foundation, The Farm Crisis: Who's in Trouble, How to Respond, National Issues Forum (Dubuque, Ia.: Kendall/Hunt Publishing Company, 1989).
6. Richard T. Rogers, "Broilers: Differentiating a Commodity," in Larry L. Duetsch, ed., Industry Studies (Englewood Cliffs, N.J.: Prentice Hall, 1993), pp. 3-32.
7. Daniel B. Suits, "Agriculture," Chapter 1 in Walter Adams, ed., The Structure of American Industry, 8th ed. (New York: Macmillan, 1990), pp. 140.
Outline
I. DEMAND AND SUPPLY ANALYSIS
A. General Definitions and Comments
1. The law of demand states that consumers will purchase more of a good at lower prices and less of a good at higher prices.
2. The law of supply states that producers will sell less of a good at lower prices and more of a good at higher prices.
3. Equilibrium exists when there is no reason for a situation to change.
a. When equilibrium exists, the quantity people plan to buy is equal to the quantity that producers plan to sell.
b. The laws of demand and supply cause the market to move to equilibrium.
B. Other Demand Factors
1. Changes in demand factors other than price of the good will result in a change in demand.
a. An increase in demand is depicted as a rightward shift of the demand curve.
b. An increase in demand means that consumers plan to purchase more of the good at each possible price.
c. A decrease in demand is depicted as a leftward shift of the demand curve
d. A decrease in demand means that consumers plan to purchase less of the good at each possible price.
2. The price of related goods is one of the other factors affecting demand.
a. Related goods are classified as either substitutes or complements.
1. A good that is used in the place of another good is a substitute.
a. An increase in the price of a good will increase demand for its substitute, while a decrease in the price of a good will decrease demand for its substitute.
2. A good that is used with another good is a complement.
a. An increase in the price of a good will decrease demand for its complement while a decrease in the price of a good will increase demand for its complement.
3. Income is another factor that can affect demand.
a. If a good is a normal good, increases in income will result in an increase in demand while decreases in income will decrease demand.
b. If a good is an inferior good, increases in income will result in a decrease in demand while decreases in income will increase demand.
Instructor's Manual 61
Consumer preferences obviously can affect demand.
C. Other Supply Factors
1. Changes in other supply factors will result in a change in supply.
a. An increase in supply is depicted as a rightward shift of the supply curve.
b. An increase in supply means that producers plan to sell more of the good at each possible price.
c. A decrease in supply is depicted as a leftward shift of the supply curve.
d. A decrease in supply means that producers plan to sell less of the good at each possible price.
2. Other factors affecting supply include technology, the prices of inputs, and the prices of alternative goods that could be produced.
a. An advance in technology, a decrease in the prices of inputs, or a decrease in the prices of alternative goods that could be produced will result in an increase in supply.
b. A deterioration of technology, an increase in the prices of inputs, or an increase in the prices of alternative goods that could be produced will result in a decrease in supply.
II. HOW CHANGES IN DEMAND AND SUPPLY AFFECT EQUILIBRIUM PRICE AND QUANTITY
A. Change in Demand
1. A change in demand will cause equilibrium price and output to change in the same direction.
a. A decrease in demand will cause a reduction in the equilibrium price and quantity of a good.
1. The decrease in demand causes excess supply to develop at the initial price.
a. Excess supply will cause price to fall, and as price falls producers are willing to supply less of the good, thereby decreasing output.
b. An increase in demand will cause an increase in the equilibrium price and quantity of a good.
1. The increase in demand causes excess demand to develop at the initial price.
a. Excess demand will cause the price to rise, and as price rises producers are willing to sell more, thereby increasing output.
B. Change in Supply
1. A change in supply will cause equilibrium price and output to change in opposite directions.
a. An increase in supply will cause a reduction in the equilibrium price and an increase in the equilibrium quantity of a good.
1. The increase in supply creates an excess supply at the initial price.
a. Excess supply causes the price to fall and quantity demanded to increase.
b. A decrease in supply will cause an increase in the equilibrium price and a decrease in the equilibrium quantity of a good.
1. The decrease in supply creates an excess demand at the initial price.
a. Excess demand causes the price to rise and quantity demanded to decrease.
C. Changes in Demand and Supply
1. If demand and supply change in opposite directions, then the change in the equilibrium price can be determined, but the change in the equilibrium output cannot.
a. A decrease in demand and an increase in supply will cause a fall in equilibrium price, but the effect on equilibrium quantity cannot be determined.
1. For any quantity, consumers now place a lower value on the good, and producers are willing to accept a lower price; therefore, price will fall. The effect on output will depend on the relative size of the two changes.
b. An increase in demand and a decrease in supply will cause an increase in equilibrium price, but the effect on equilibrium quantity cannot be determined.
1. For any quantity, consumers now place a higher value on the good, and producers must have a higher price in order to supply the good; therefore, price will increase. The effect on output will depend on the relative size of the two changes.
2. If demand and supply change in the same direction, the change in the equilibrium output can be determined, but the change in the equilibrium price cannot.
a. If both demand and supply increase, there will be an increase in the equilibrium output, but the effect on price cannot be determined.
1. If both demand and supply increase, consumers wish to buy more and firms wish to supply more so output will increase. However, since consumers place a higher value on each unit, but producers are willing to supply each unit at a lower price, the effect on price will depend on the relative size of the two changes.
b. If both demand and supply decrease, there will be a decrease in the equilibrium output, but the effect on price cannot be determined.
1. If both demand and supply decrease, consumers wish to buy less and firms wish to supply less, so output will fall. However, since consumers place a lower value on each unit, but producers are willing to supply each unit only at higher prices, the effect on price will depend on the relative size of the two changes.
III. U.S. AGRICULTURE
A. Economic and Historical Characteristics
1. The percentage of workers in agriculture has fallen since 1800, and the number has fallen since the 1920s.
a. The downsizing of agriculture employment has been accompanied by large reductions in the number of farms.
2. Advances in technology are largely responsible for the downsizing of agriculture.
a. Technological advances have significantly increased the supply of agriculture products.
b. Demand for agriculture products has not kept pace with the increases in supply.
1. Population has not grown at a fast enough rate to keep pace with the increase in supply.
2. Income has increased, but it has not resulted in a proportionate increase in demand for agriculture products.
3. The farm population is better off both relatively and absolutely than in previous time periods.
a. Changes in technology and decreases in the price of agriculture output has decreased the demand for labor in agriculture.
b. Tremendous growth of opportunities have resulted in large decreases in the supply of labor in agriculture.
c. Because the decreases in supply have outweighed the decreases in demand, wages in agriculture have increased.