Question

Consider the market for wholesale market for milk in Tasmania in 2019 with a perfect elastic supply curve and downward sloping demand curve. The current equilibrium price of milk is $0.55 is per litre and 950 million litres of milk is bought and sold.

Suppose that in 2020 due to lower feed costs for dairy cows, the price drops to $0.45 per litre.

a. Calculate the change in the price using the cross/mid -point formula. Use the demand elasticity for wholesale milk of ε = - 0.5 to estimate the % change in quantity demanded for wholesale milk in 2020.

b. Use the following formula Q₁= (200% + %∆Q) ÷(200% - %∆Q) Q₀ to show that the quantity of wholesale milk bought and sold in 2020 is 1050 litres.

c. Illustrate in your diagram and calculate the change in the consumer surplus as result of the lower feed costs for dairy cows.

d. Explain why the consumer surplus for consumers of Tasmanian milk has changed?

Answer 1

The statement of question gives equlibrium price and quantity of milk.

- The perfectly elastic supply curve is a horizontal straight line which has elasticity infinite.

- The demand curve slopes downward , having negetive slope.

-The intersaction of both curves has already determined the Equilibrium price = $ 0•55 per litre and 950 litres of milk.

- Now ,suppose the price of milk Decreases to 0•45$ per litre due to fall in cow feed prices ( input cost), it will change the position of supply curve, now it will shift below the initial horizontal line,at 0•45.

(a) * Change in price of milk. = 0•10 $ per litre of milk.

* Calculating the percentage change in quantity demanded and new quantity demanded by mid point method of elasticity of demand ------------:

Mid point method formula=( q¹-q0)/1/2(q¹+q0)÷(p¹+p0)/1/2(p1-p0)

Where q0= initial quantity=950

q¹= new quantity

p0= initial price =0•55

p¹= new price = 0•45

Ed= 0•5

So, substituting all given values in formulae----

0•5={( q¹-950)/(q¹+950)}×{(0•45+0•55)/(0•45-0•55)}

Q¹-950/q¹+950=5/100

100q¹-95000= 5q¹+950×5

q¹= 99750/95=. 1050

So, new quantity demanded due to fall in milk price = 1050

# percentage change in quantity demanded = (change in demand /initial demand)×100

(1050-950/950)×100=10•53%

* b) The mid point formula is already used and the new quantity demanded has been calculated in part (a)

(C)The change in consumer surplus will be shown with the help of two graphs. Initial consumer surplus at Equilibrium price and quantity is shaded area ABE in grah below.

*c)

When the price of milk Decreases, the the consumer surplus also changes.The new consumer surplus is shown in graph (2) below in shaded area ACE¹---

We can easily differentiate the new consumer surplus the total shaded area ,that is area

ABE + area BEE¹C= area ACE¹

* Change in consumer surplus ------

Area BEE¹C

d) The consumer surplus is the difference between the price what buyers are willing to pay and what they actually pay.

When price was somewhat higher $0•55, they were buying 950 litres, but with low price ,they are willing to buy more milk, so the portion of consumer surplus increases.

This I the reason of increase in consumer surplus for the milk in Tasmania.