Question

Consider the market for wheat. Most farmers have loans that are based on flexible interest rates (i.e. they change with the market rate). Starting off from equilibrium, demonstrate graphically (and write into a table) what happens to P,Q,q, and Profits in the short-run, and long-run, if the interest rate decreases. Provide explanation please!

Answer 1

Most farmers of wheat have loans that are based on flexible interest rates. That means they change with market rate.
Suppose initially wheat market is equilibrium at point E where demand for wheat and supply of wheat intersects at price level P and quantity of wheat Q level
Market loans are based on interest rates. Here interest of loans decreased. It will reduce cost of borrowing of money. It will encourage farmers to take loan and invest in production of wheat.
In short run, as production of wheat increases, supply of wheat will increase along with same demand for wheat. Supply curve of wheat will shift to right. It rises the price level of wheat from p to P1 and quantity of wheat from Q to Q1. As price increases, profit of wheat farmers increases in short run. Because they can sell wheat at higher prices than before.
In long run, when price and supply of wheat increases, it will create surplus of wheat in market. When price of wheat increases, demand for wheat will decline. Then demand curve of wheat will shift leftward. It will decline the long run profit of farmers due to fall in demand for wheat. Thereby price and quantity will fall. On other side as interest rate increases, investment level rises and as a result it will increase the aggregate demand and price level in the economy. Higher price level causes inflationary pressure in everywhere