Question

(a) Wheat and oats, which are both used to make cereal (hence they are substitutes), are grown in the Prairies. What would happen to supply and demand of oats if the price of wheat were to rise? Explain your solution. (2+2)

(b) Present a properly labelled graphical presentation of the above situation. You may support the graphical representation with the explanation of the graph to clearly explain the scenario

Answer 1

a.Wheats and oats, which are both used to make cereal are grown in prairies. Wheats and oats are substitutes. So producer can use wheats and oats depends on its prices. Suppose price of wheat rises , then demand on oats will rise. Because cross elasticity of substitutes are positive, that means rise in price of commodity X will results increase in demand on commodity Y. Likewise, increase in price of wheat increases the demand on oats. Increase in price of wheat reduces the demand for wheat , supplier will increase supply of wheat due to increase in its prices. But demand will reduce. Increase in price of wheat,will increase the demand for oats,Supply of oats remain constant b. Suppose initially the price of wheat is Pw and price of oats is Po . Then price of wheats rises to Pw1. Demand supply curve oats intersects at point E on Q1 quantity of oats and price level Po. But rise in prices of wheat increases the demand for oats. The demand curve of oats will shift rightward to D1 from initial demand curve D. Supply curve of oats will remain same. But in long run ,due to higher demand , price of oats will rise