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 liter. Illustrate the change in equilibrium price and quantity and any changes in the demand or supply of wholesale milk in Tasmania.

Answer 1

Supply curve is perfectly Elastic. This means at a price the firm is willing to supply any amount of Output.

Demand curve is downward-sloping. In intersection of demand and supply curves gives the equilibrium price. Accordingly, the equilibrium Market price of milk is $0.55 per litre and Quantity of milk sold and bought in the market is 950 million litres.

Now in 2020, due to lower feed costs for dairy cows, the price drops to $0.45 per litre. The going down of price can be explained as follows. Feed cost is a cost of production for dairy Producers. Since feed cost went down, the cost of production of dairy producers also got down. This means that there will be shift of supply curve downwards. The point at which new supply curve intersects demand curve is the equilibrium point. At this equilibrium point, new Equilibrium price is $0.45 per litre. The new equilibrium Quantity will be greater than the previous equilibrium Quantity of 950 million litres. This is illustrated in the Graph below.