Question

According to an article in the Wall Street Journal, in early 2017, President Donald Trump was considering whether to reverse a requirement by the Environmental Protection Agency that oil refiners increase the amount of ethanol they blend with gasoline. If the requirement were to remain, the result would be an increase in demand for ethanol, which is made from corn. Many U.S. farmers can use the same acreage to grow either corn or soybeans. Use a demand and supply graph to analyze the effect on the equilibrium price of soybeans resulting from an increase in the demand for corn.

Short answer

The increase in demand for corn is likely to result in a decreased supply of soybeans, leading to an increase in the equilibrium price of soybeans. The equilibrium quantity of soybeans will be decreased.

Step-by-step solution

Identify Initial Equilibrium

First, draw a demand and supply graph for soybeans, indicating the initial equilibrium price and quantity (let's call them \(P_1\) and \(Q_1\)). The initial situation is characterized by a certain level of demand and supply for soybeans.

Analyze the Increase in Demand for Corn

If the demand for corn increases (due to an increase in ethanol blending requirement), farmers who can grow either corn or soybeans on their land are likely to switch some of their production capacity to corn. This will lead to a decreased supply of soybeans.

Adjust Soybeans Supply Curve and Find New Equilibrium

Reflect this decreased supply of soybeans on your graph by shifting the supply curve for soybeans to the left. As the supply curve shifts, the equilibrium price of soybeans will go up to a new level (let's call it \(P_2\)), while the equilibrium quantity will decrease from \(Q_1\) to a new level \(Q_2\).

Key concepts

Demand and Supply Graph

Understanding the movement of prices and quantities in a market can be greatly aided by the use of a demand and supply graph. This fundamental economic model graphically represents the relationship between the quantity of a good or service that consumers are willing to purchase at a given price (demand), and the quantity that producers are willing to sell (supply).

At the intersection of the demand and supply curves on this graph is the equilibrium price and quantity. The equilibrium price is the price at which the amount of the product consumers wish to buy equals the amount that producers wish to sell, and the equilibrium quantity is the corresponding amount of goods.

When interpreting such graphs, it is crucial to note the axes: the vertical axis represents the price level, while the horizontal axis represents quantity. Shifts in these curves indicate changes in market conditions. For instance, a shift to the right of the demand curve signifies an increase in demand, leading to a higher equilibrium price and quantity if the supply remains constant.

Increase in Demand

An increase in demand refers to a situation where, for any given price, consumers are prepared to purchase more of a good or service. This heightened desire could be the result of various factors, such as an increase in consumer income, a change in preferences, or in the case of our exercise, a regulatory change that could boost the demand for ethanol from corn.

Increases in demand are represented on a demand and supply graph by a rightward shift of the demand curve. This shift implies that at the original equilibrium price, there is now a higher quantity demanded. For markets where the supply remains unchanged, such an increase in demand typically results in a higher equilibrium price and a larger equilibrium quantity.

To capture this effect, one needs to carefully analyze how a change in one market, such as the market for corn, can impact related markets, which in this scenario is the market for soybeans. As farmers shift their focus to producing more corn, this change in production priority can cause a ripple effect, influencing supply in the interconnected market.

Equilibrium Quantity

The equilibrium quantity is an essential concept within the study of economics. It represents the amount of a good or service that is bought and sold at the equilibrium price. This quantity reflects a state of balance in the market where supply equals demand. Any changes in the conditions of demand or supply will alter this delicate balance and result in a new equilibrium quantity.

In our case, the increased demand for corn, due to its use in ethanol, leads to a decision by farmers to replant fields with corn instead of soybeans. This change decreases the supply of soybeans, reflecting a leftward shift of the supply curve on the graph. The new point where the supply curve for soybeans intersects with the demand curve will represent the new, typically reduced, equilibrium quantity for soybeans.

This change in equilibrium quantity is crucial for markets and industries to understand as it can influence business decisions, prices, and even the broader economy. By understanding how equilibrium quantities are determined, stakeholders can make more informed decisions about production, investment, and policy-making.