Economics In order to understand the ways that different changes in the external environment will affect the demand for milk, some assumptions need to be made with respect to the milk market. We know that demand for milk will increase as wealth increases, which is the result of milk being something of a luxury item (Arnold, 2007). This means that there is some degree of correlation between wealth and milk consumption, and that implies that if wealth declines, milk consumption will also decline.

We also know that demand for milk is somewhat price inelastic. When prices rise, people still pay them (Dohery, 2007). This is the result of two factors. The first is that there is a baseline demand for milk that is not going to be affected by price. The second is that the demand for milk is affected more by the wealth of the purchaser than the cost of the milk. We will also assume that there are substitutes and complements for milk. There are many alternative milk products, like soy milk or rice milk. These are not perfect substitutes, however. Many milk buyers will not see these as viable substitutes, just as many vegetarians and vegans will not see them as perfect substitutes for milk, as they would not normally drink milk anyway. As well, there are complementary products, one of which would be cookies. In considering the affect of complementary products on the demand for milk, both the relationship between the demand for the complementary product and the cross-price elasticity of demand with milk need to be taken into consideration.

If more people start drinking soy milk, some of these people will be people who would otherwise have consumed milk. This should have the affect of reducing demand for milk, as fewer consumers are consuming milk, and some who remain milk consumers are drinking less of it. This is because soy milk is a substitute (albeit an...

Consumers of soy milk are often going to be directly substituting soy milk consumption for milk consumption, so it is reasonable to expect that an increase in soy milk consumption is going to result in a decrease in demand for milk. In this case, the supply of milk is not likely to change. The response by milk producers is more likely to reduce the cost of milk so it is better value compared to the cost of soy milk. They may also seek foreign markets although those are usually protected with respect to dairy.
A mad cow epidemic is likely to have two different affects on the milk market. The first is that consumers are likely to reduce milk consumption. So demand for milk will fall. Milk producers, however, may not actually be affected by the mad cow epidemic. In that case, supply would remain the same and producers would be forced to reduce the price of milk in order to better align it with the new demand. Foreign markets would not be an option in the event of mad cow crisis. Another possibility is that producers would be forced to liquidate their herds if those herds were subject to the epidemic. Under such a scenario, the supply of milk would decline, possibly even more than the demand for milk. That would mean that milk would become scarce and might actually rise in price, even with shrinking demand.

If the price of milk increases, demand for milk will fall. As we have seen above, the demand for milk has a low price elasticity of demand. Thus, demand will not fall much, so it is expected that supply will remain the same. However, demand will fall a little bit as some consumers will reduce their purchases of milk. Additionally, milk substitutes like soy milk will become a more viable option for some consumers.

If the government imposes a price ceiling on milk (many governments do this by way of subsidies for farmers),…