Economics Commentary: Ethanol as a substitute fuel.

As to the decrease in supply, one must look at changes in supply. The prices of resources used to produce corn is rising, therefore, the lowest price a producer of ethanol that uses corn is willing to accept rises, so supply of the good decreases. The increase in the price of corn leads to a decrease in the supply of ethanol. Another major factor is expected future prices. The price of corn is expected to increase in the future, and the return from selling the good in the future is higher than it is currently. The supply decreases today, however will most likely increase in the future. The prices of related goods produced also affect the supply. A substitute of corn would be, for example, petroleum. If the price of corn increases, the supply of petroleum, decreases because they can be produced using the same resources, land and labour. Land can be used to plant corn, or it can be drilled to extract oil from under the earth’s surface.  

In regards to the substitution effect, as the opportunity cost rises, consumers seek substitutes for it so quantity demanded decreases for that good, and they will then buy more of its substitutes. In this case, the substitute is ethanol, which is being mixed into gasoline. The opportunity cost for using ethanol increases, because of its many advantages over traditional gasoline. In addition, corn and soybean farmers have a higher incentive to produce more crops for fuel- the government gives out subsidies of 45 cents per bushel for producing crops for ethanol.

So, what can this entail in the future? By 2012, as much as 30 percent of the corn grown in the United States may go to ethanol production. That diverts corn from food production, raising the cost of food. Food prices in the United States increased six-tenths of one percent in February 2011. Because food is a necessity, consumers are spending higher percentages of their income on it, leaving less to buy other goods that they previously were able to afford, due to the income effect. Corn farmers are specializing in the production of corn for the production of ethanol and not for food as chemicals unsafe for humans to eat are used to speed up the growing process. Therefore, the amount of corn grown with human health in mind is reduced. Is ethanol a good idea, or will it raise food prices, the price of corn and eventually the price of fuel itself? We will see in the future, however, at this point, the production of ethanol is a booming industry.