Question

3.       According to the Australian Wool Innovation, severe drought conditions in Australia contributed to the lowest level of wool production in 50 years. This record low production has driven up prices sharply in Australian wool markets. Meanwhile, the price of raw cotton increased significantly for the first time in many years.

a.       Illustrate this observation with one demand and supply graph for the market for Australian wool and another demand and supply graph for raw cotton.

b.       Make sure that your graphs clearly show (1) the initial equilibrium before the decrease in the supply of Australian wool and (2) the final equilibrium.

c.       Use arrows to indicate any shifts in the demand and supply curves for each market.

d.       Label your graphs fully and write an explanation of your work.

Answer 1

(a) The above diagram shown the situation explained above. The supply curve shifts up because of low supply driven by drought conditions.

(b) Consider the initial demand curve is represented by curve D and supply curve is represented by curve S as shown in the above diagram. The equilibrium price and quantity are determined at the intersection point of demand and supply curves, i.e., at point E. Accordingly, the equilibrium price and quantity before the drought conditions were P* and Q*.

(c) As mentioned in (a), there would be a shift in supply curve from S to S' as shown in the diagram. The direction of the shift of the supply curve is shown by the arrows.

(d) As a result of the drought situation, the supply curve shifts up and the price level increases sharply from P* to P** as explained. Consequently, the equilibrium output falls from Q* to Q**.