Question

Suppose that most wheat farms are suffering losses. Now suppose that a new scientific study shows that eating four slices of whole wheat bread per day is an effective means of weight control, lowers blood pressure, and reduces the likelihood of heart disease. Assume that this study leads to the typical wheat farm earning an economic profit. Use two graphs to illustrate the effect of the release of the study: one graph showing the effect on the market for wheat and another graph showing the effect on a representative wheat farm. Be sure your graph for the wheat market shows any shifts in the market demand and supply curve and any changes in the equilibrium market price. Be sure that your graph for the representative farm includes its marginal revenue curve, marginal cost curve, average total cost curve, any change in its demand curve, and the area showing its loss before the release of the study and its profit after the release.

Short answer

The scientific study significantly increased the demand for wheat in the market, causing a rightward shift in the market's demand curve. This led to an increase in both the equilibrium price and quantity. On the farm-level, this increased demand helped diminish the farm's losses, where the new demand made the price per unit exceed the average total cost, leading to an economic profit for the farm.

Step-by-step solution

Draw the Initial Equilibrium

Draw two graphs, one for the market for wheat and one for a representative wheat farm. Initially, the market is in balance with a supply curve (S1) and demand curve (D1) intersecting at equilibrium price (P1) and quantity (Q1). For the farm, draw the marginal cost curve (MC), average total cost curve (ATC), and marginal revenue curve (MR) showing the farm is at equilibrium but experiencing losses (the ATC is above the MR at the equilibrium quantity).

Illustrate the Effect of the Study

The study increases the demand for wheat, shifting the market demand curve to the right (to D2). This causes the equilibrium price to rise (to P2) and the quantity demanded to increase (to Q2). On the farm graph, the demand curve now becomes more elastic due to increased demand and shifts to D2, leading to a new equilibrium where the MR2 curve intersects with MC. Outline the initial loss area (the area between ATC1 and MR1, to the left of Q1) and the new profit area (any area between MR2 and ATC2 to the right of the new equilibrium quantity).

Interpret the Graphs

The market graph shows that after the scientific study, the demand for wheat increased causing a rightward shift in the demand curve. This leads to an increase in both the equilibrium price and quantity demanded for wheat. The representative farm's graph shows that the increased market demand reduces the farm's losses and eventually leads to an economic profit as the price per unit exceeds the average total cost at the new equilibrium.

Key concepts

Demand and Supply Shifts

Understanding the interplay between demand and supply shifts is crucial in analyzing market dynamics. In our exercise scenario, a scientific study boosts wheat's public perception as a healthy food choice, resulting in a spike in consumer demand. When demand increases, the demand curve on a graph shifts to the right.

This shift occurs because, at any given price, consumers are now willing to purchase more wheat due to the perceived benefits highlighted by the study. In a graph depicting market demand and supply, the initial equilibrium is disrupted, leading to a new higher equilibrium price and quantity. On the individual farm's graph, this shift increases the price they can charge per unit, represented by an upward shift in the marginal revenue curve.

It's pivotal for students to connect the increase in demand with a rightward shift in the demand curve and to recognize that this shift, in isolation, leads to higher market prices and quantities.

Economic Profit and Loss

Economic profit and loss are measures of a farm's financial well-being. When a farm's average total costs exceed the price it receives for wheat, it incurs an economic loss. Before the scientific study, our representative wheat farm was in this predicament. The area of loss can be visualized on a graph as the space where the average total cost curve is above the marginal revenue curve.

After the release of the study, the new-found demand for wheat leads consumers to value and pay more for wheat, which reflects an upward shift in the farm’s demand curve and an increase in economic profit. If the area between the new marginal revenue (representing increased prices) and average total cost (representing expenses per unit) shows the marginal revenue above the average total cost, it represents an area of economic profit. Being able to visualize these areas of loss and profit helps students understand the direct impact of market changes on a farmer's bottom line.

Marginal Revenue and Cost

Marginal revenue (MR) is the additional income from selling one more unit of a good, while marginal cost (MC) is the cost of producing that additional unit. Economists use these concepts to determine the most profitable level of production. In a graph, when MR exceeds MC at a given production quantity, a firm can increase profits by increasing output.

Conversely, if MC exceeds MR, the firm should reduce its output to maximize profits. The intersection of marginal revenue and marginal cost curves defines the profit-maximizing quantity of output. Our study-induced demand shift for wheat increased the farm's marginal revenue without necessarily affecting the marginal costs, leading to an extension of output where MR again intersects MC. This intersection signals where the farm maximizes profit post-study.

Market Demand Increase

A market demand increase, such as the one caused by the favorable wheat study, implies more consumers are interested in purchasing wheat at every price point. This increased consumer interest translates to the rightward shift of the demand curve in a market graph.

When market demand increases, it can lead to producers increasing prices and ramping up production to meet the higher demand, resulting in economic profit for sellers. It's important for students to associate an increase in market demand with the uptake in producer activity and the jump in the equilibrium price and quantity in the market. These changes not only reflect consumer preferences but also play a significant role in informing producers' supply decisions.