Microeconomics_4__Besanko

Microeconomics_4__Besanko


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of consumptions of renewable
fuels used in the United States between 2009 and 2022. The mandates called for a sharp increase in the
amount of corn-based ethanol consumed until 2015, at which point the growth in renewable fuel con-
sumption would come from other renewable fuels. The renewable fuel mandates resulted in an increase
in the amount of ethanol-based fuel produced in the United States (such as E85, a blend consisting of 
85 percent ethanol and 15 percent gasoline) and thus increased the demand for corn even more. The 
increased demand for corn that resulted from the growing use of ethanol in the United States is a key
reason why the U.S. corn price rose sharply in 2007
and 2008. The Congressional Budget Office estimates
that of the $1.75 per bushel increase in the price of
corn from April 2007 to April 2008 (i.e., from $3.39 to
$5.14), 28 percent to 47 percent of the increase can be
attributed to the increased demand from U.S. ethanol
producers.1
So what accounted for the remaining portion of
the large increase? Part of the increase was due a
growth in demand for corn resulting from the rapid
expansion of the U.S. and global economies that
took place during the \u201cbubble\u201d years of 2005\u20132008.
Another part of the increase was due to changes on
the supply side of the corn market. Increases in the
price of oil increased farmers\u2019 production costs.
Furthermore, heavy rains and flooding in the U.S.
Corn Belt in early 2008 caused fear that a large 
portion of the 2008 corn harvest would be wiped out.
1\u201cThe Impact of Ethanol Use on Food Prices and Greenhouse-Gas
Emissions,\u201d Congressional Budget Office (April 2009).
28
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All of these factors driving the price of corn upward went away in the latter half of 2008 and 2009:
The economic crisis reduced the global demand for corn. Oil prices fell, giving farmers some relief from
high fuel prices. Fear of a greatly reduced corn harvest in 2008 proved to be exaggerated. And weather
conditions returned to normal in 2009. As a result, in the second half of 2008, the price of corn fell
from its June 2008 peak of $5.47 per bushel to about $3.90 per bushel in early 2009. Because the shifts
in ethanol demand continue to affect the market for corn, this price exceeds the $2.00 per bushel level
of the early 2000s.
The tools of supply and demand analysis that we introduced in Chapter 1 can help us understand
the story that unfolded in the corn market over the past decade. In fact, they can help us understand
the pattern of prices that prevail in many markets, ranging from fresh-cut roses to electricity to pepper.
CHAPTER PREVIEW After reading and studying this chapter, you will be able to:
\u2022 Describe the three main building blocks of supply and demand analysis\u2013\u2013demand curves, supply
curves, and the concept of market equilibrium.
\u2022 Analyze how changes in exogenous variables shift the demand and supply curves and thus change the
equilibrium price and quantity.
\u2022 Explain the concept of price elasticity.
\u2022 Calculate the price elasticity of demand for specific demand curves.
\u2022 Explain how price elasticity of demand is related to total revenue.
\u2022 Discuss the factors that determine the price elasticity of demand.
\u2022 Contrast the market-level price elasticity of demand with the brand-level price elasticity of demand.
\u2022 Explain and contrast other elasticities: the income elasticity of demand, the cross-price elasticity of 
demand, and the price elasticity of supply.
\u2022 Indicate why the short-run price elasticities of demand and supply may differ from the long-run price
elasticities of demand and supply.
\u2022 Use \u201cback-of-the-envelope\u201d techniques to determine key properties of demand and supply curves
with only fragmentary data on prices, quantities, or elasticities.
2.1
DEMAND,
SUPPLY, AND
MARKET
EQUILIBRIUM
Chapter 1 introduced equilibrium and comparative statics analysis. In this chapter, we
apply those tools to the analysis of perfectly competitive markets. Perfectly competitive
markets comprise large numbers of buyers and sellers. The transactions of any individ-
ual buyer or seller are so small in comparison to the overall volume of the good or ser-
vice traded in the market that each buyer or seller \u201ctakes\u201d the market price as given
when making purchase or production decisions. For this reason, the model of perfect
competition is often cited as a model of price-taking behavior.
Figure 2.2 illustrates the basic model of a perfectly competitive market. The
horizontal axis depicts the total quantity Q of a particular good\u2014in this case corn\u2014
that is supplied and demanded in this market. The vertical axis depicts the price P at
which this good is sold. A market can be characterized along three dimensions:
2.1 DEMAND, SUPPLY, AND MARKET EQUILIBRIUM 29
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30 CHAPTER 2 DEMAND AND SUPPLY ANALYSIS
commodity\u2013\u2013the product bought and sold (in Figure 2.2 this is corn); geography\u2013\u2013the
location in which purchases are being made (in Figure 2.2 this is the United States);
and time\u2013\u2013the period of time during which transactions are occurring (in Figure 2.2,
this is the year 2009, when corn prices were about $4 per bushel).
DEMAND CURVES
The curve D in Figure 2.2 is the market demand curve for corn. It tells us the quan-
tity of corn that buyers are willing to purchase at different prices. For example, the
demand curve tells us that at a price of $3 per bushel, the annual demand for corn
would be 14 billion bushels, while at a price of $4 per bushel, the annual demand for
corn would be only 11 billion bushels.
Corn supplies are bought by companies (such as Archer Daniels Midland and
General Mills) that process the corn into intermediate products (e.g., high fructose
corn syrup or corn grits), which in turn are used to make final products (e.g., soft
drinks or breakfast cereal). Part of the demand depicted in Figure 2.2 is derived
demand\u2013\u2013that is, it is derived from the production and sale of other goods. For ex-
ample, the demand for high-fructose corn syrup is derived from the demand for soft
drinks in which it is used as a sweetener (instead of sugar). Corn is also purchased by
brokers and wholesale distributors, who then sell it to retailers who then resell it to
final consumers. Thus, another part of the demand for corn depicted in Figure 2.2
is direct demand\u2013\u2013demand for the good itself. The demand curve D is a market
demand curve in that it represents the aggregate demand for corn from all the corn
purchasers in the U.S. market.
In Figure 2.2, we have drawn the demand curve with price on the vertical axis
and quantity on the horizontal axis. This representation emphasizes another useful
FIGURE 2.2 The Market for Corn in the
United States in 2009
The curve labeled D is the demand curve for
corn. The curve labeled S is the supply curve
for corn. Point E, at which the two curves 
intersect, is the market equilibrium.
Quantity (billions of bushels per year)
Pr
ic
e 
(do
lla
rs 
pe
r b
u
sh
el
)
11 14
$3
$4
9
E
S
D
market demand curve
A curve that shows us the
quantity of goods that con-
sumers are willing to buy 
at different prices.
derived demand
Demand for a good that is
derived from the produc-
tion and sale of other
goods.
direct demand
Demand for a good that
comes from the desire of
buyers to directly consume
the good itself.
c02demandandsupplyanalysis.qxd 6/14/10 1:39 PM Page 30
2.1 DEMAND, SUPPLY, AND MARKET EQUILIBRIUM 31
interpretation of the demand curve that we will return to in later chapters. The demand
curve tells us the highest price that the \u201cmarket will bear\u201d for a given quantity or sup-
ply of output. Thus, in Figure 2.2, if suppliers of corn