Supply and Demand - Applying the Theory

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Jason Lee 12HT 26th November 2007

Economics HL

Supply & Demand: Applying the Theory

In a growing world, milk is the new oil

The purpose of this report is to analyze and interpret the article “In a growing world, milk is the new oil”, to determine the effect of different economic factors on supply and demand, and how that can affect the equilibrium price.

        “There’s a world shortage of milk”, states Philip Goode, and this is due to the rising incomes “from China and India to Latin America to the Middle East.” As people become wealthier, they are willing to buy a higher quantity of milk. “The average person in China now consumes more than 25 liters…up from 9 liters in 2000.” This results in a shift of the demand curve to the right (Figure 1), which causes disequilibrium and leads to a shortage (Q2 - Qe), since people now demand more quantity Q2 than the market can supply at the time, Qe. This shortage pushes up the price of milk, for at the originally supplied quantity Qe, people are actually willing to pay price Pe2 on the new demand curve.

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        Although this new demand will attract potential producers into the market as they see a greater potential for making profit, during the process of adjustment, the new supply may not come fast. Currently, the milk industry is operating at optimum capacity to meet demands. There is a lack of spare capacity due to a shortage of cows and limited time to adjust to the rise in demand. “The sheep farmers…are trying to convert to dairy, but there is a two-year waiting list,” thus the relatively inelastic supply curve S1 as seen in Figure 2 will only become more elastic to ...

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