Question

Draw the supply and demand for wheat on a graph, and indicate the equilibrium price and quantity. Suppose rice and wheat are consumption substitutes, and corn and wheat are production substitutes. Describe and show what happens in the market for wheat when 2 events occur at the same time: 1) the price of corn increases, and 2), a drought (lack of rain) occurs in rice-growing regions, causing the supply of rice to fall.. Suppose the drought in rice has a bigger magnitude impact on the market for wheat. than the price of corn increasing. Show the appropriate curve shifts in the market for wheat and indicate the new equilibrium price and quantity.

Answer 1

The graph:

D is the initial demand curve of wheat and S is the supply curve of wheat. P* is the equilibrium price and Q* is the equilibrim quantity.

When the price of corn (production substitute) increases, producers produce more of corn (more profitable), so the supply of wheat decreases. Therefore, the supply curve shifts from S o S1. Quntity decreases to Qc and price increases to Pc.

On the other hand, when the supply of rice (consumption substitute) decreases due to drought, consumers shift their preferences to wheat and so, the demand for wheat increases. The demand curve shifts from D to D1. Price increases to Pr and quantity increases to Qr.

As the drought of rice has greater impact on the wheat market than the increase in the price of corn, the increase in demand is greater than the decrease in supply.