Question

In early 2011 , even though cotton prices were high, cotton farmers in China began to hoard (rather than sell) most of the crop they had harvested, filling spare rooms and even living areas of their homes with cotton. Given the cost and inconvenience of storing large amounts of cotton rather than selling it, what could explain this behavior? [Hint: Review the section of this chapter on factors that shift the supply curve.] Could this behavior explain why cotton prices were high during this period? Explain, using the concepts of supply and demand.

Short answer

The Chinese cotton farmers' actions of hoarding the crop in early 2011 reduced the supply of cotton in the market. Given demand was constant or increasing, this led to an increase in cotton prices according to the law of supply and demand. It can be concluded that farmers hoarding the cotton caused the high cotton prices during this period.

Step-by-step solution

Identify the farmer's actions

We notice that farmers are stockpiling the cotton, and not selling it, even though the prices were high. This suggests that the supply of cotton in the market is being reduced.

Analyze the influence of farmer's actions

Reduced supply in the face of consistent or increasing demand is one of the causes for price increases. If the cotton farmers are hoarding their harvest, the quantity of cotton available for purchase in the market decreases. If the demand remains the same or increases, this will drive the price of cotton up according to the law of supply and demand.

Evaluate the motive behind the farmers' actions

The farmers may have anticipated that the cotton prices would rise further so they preferred to wait and sell their crop later when the prices could potentially be higher. This is consistent with the factor that shift supply curve, where expectation for future prices affect current supply.

Determine the relation of farmers' behavior to the high cotton prices

Yes, the farmers' behavior can explain why cotton prices were high during this period. By reducing the quantity supplied, prices are driven up, provided the demand remains constant or continues to increase.

Key concepts

Factors That Shift the Supply Curve

Understanding the factors that shift the supply curve is crucial for analyzing market behaviors. The supply curve represents the relationship between price and the quantity of a good that producers are willing to sell. Several factors can cause the supply curve to shift, including:

• Production Costs: Changes in production costs, such as raw materials, labor, and machinery, can affect supply. Higher costs can decrease supply, shifting the curve to the left.
• Technology: Advances in technology can increase supply by making production more efficient, shifting the supply curve to the right.
• Number of Suppliers: An increase in the number of suppliers will typically result in a greater quantity supplied at each price, shifting the supply curve to the right.
• Expectations: Producers' expectations of future prices can influence current supply levels. If prices are expected to rise, producers may withhold goods and reduce supply, shifting the supply curve to the left.
• Government Policies: Taxes, subsidies, and regulations can also shift the supply curve. For example, a tax can decrease supply, while a subsidy can increase it.

In our textbook exercise, farmers' expectation of higher future cotton prices prompted them to hoard their product, shifting the supply curve to the left.

Law of Supply and Demand

The law of supply and demand is one of the most foundational concepts in economics, describing how prices vary based on the balance between the quantity of a good or service desired by buyers and the quantity supplied by producers. Here's how it works:

• Law of Supply: As the price of a good increases, producers are willing to offer more of it for sale. As the price decreases, producers are less inclined to sell.
• Law of Demand: As the price of a good increases, consumers are less likely to purchase it. Conversely, as the price decreases, consumers are more inclined to buy.

When these two laws are combined, they determine the market price and quantity of goods. A high cotton price, as in our case, suggests that the quantity demanded by consumers remains steady or is increasing, while the quantity supplied is limited because of the farmers' hoarding behavior.

Market Equilibrium

Market equilibrium occurs where the quantity supplied equals the quantity demanded at a certain price point, known as the equilibrium price. At this price, the market is in balance, and there is no surplus or shortage of goods.

However, if an external factor disrupts this balance, the market will adjust by shifting either the supply or demand curve until a new equilibrium is reached. For example, if farmers decide to hoard cotton, the supply decreases, which, if the demand remains constant, pushes the equilibrium price higher and creates a new market equilibrium point. Understanding this dynamic is critical when analyzing shifts in market conditions, like the one seen with the cotton prices in the exercise.

Farmer's Hoarding Behavior

Farmer's hoarding behavior significantly impacts the supply side of the market. By holding back products in anticipation of future price increases, farmers effectively decrease the current supply. This behavior can stem from various motivations, such as:

• Price Expectation: Farmers may expect higher prices in the future, prompting them to store goods rather than sell at current market prices.
• Risk Aversion: Farmers might hoard as a form of risk management, to avoid the potential loss from price drops.
• Market Power: In some cases, a collective hoarding by a large number of farmers can influence market prices and increase bargaining power.

In the context of the exercise, Chinese cotton farmers' hoarding played a role in driving up cotton prices by restricting the supply that was available to the market.