This article offers an excellent lesson in supply and demand in a real world scenario...The focus is the cotton market but it mentions corn as well.
This graph shows the market for corn and cotton at a starting equilibrium point...
What is the connection between cotton and corn? Both are grown on land that is suitable for growing either, for the most part. Farmers are relatively indifferent as to which one to grow, but they are motivated by price.
Since 2006, cotton acreage has declined year-over-year as farmers reacted to higher corn and soybean prices that were driven up in part by biofuel demand. In 2009, U.S. cotton plantings totaled only 9.15 million acres, a 26-year low....The DEMAND for Corn INCREASED because of the Ethanol mandate of 2006 requiring ethanol to be added to the fuel supply. This dramatically INCREASED the DEMAND for corn by ethanol producers. This is shown in "Graph #1.
The demand curve shifts to the right ("D1") indicating and increase in demand. The price of corn INCREASES ("B"). Cotton farmers, attracted by the increase market price for corn PLUS the Federal subsidies, quickly started to produce corn instead of cotton. This led to the DECREASE in SUPPLY of cotton on the market. This is indicated in "Graph #2" with a leftward shift of the supply curve ("S1"). The market price of cotton ("B") is now higher too!
The world will need all the extra cotton acreage it can get this year, given that demand is expected to rebound. Ron Lawson, managing director at Logic Investment Services in Napa Valley, Calif., pointed to U.S. Department of Agriculture data that peg world cotton consumption at 114.36 million bales in the current 2009-10 marketing year that ends July 31. That figure is 10% higher than production estimates in the same time frame.The anticipated INCREASE in demand will, potentially, further increase the upward pressure on the price of cotton. The increase in demand is shown in this graph...
The demand curve shifts to the right ("D1") indicating an increase in demand in the market for cotton. The price increases to "C", higher still!
Questions:
1. What signal is the elevated price of cotton going to send farmers of corn, wheat, soybeans?
2. What may happen to the price of clothing?
3. What may happen to the price of corn as a result of the increase in the price of cotton?
4. In response to question #3, what may happen to the price of gasoline?
No one said this was going to be easy...:)
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