Market for Milk if More

Market for Milk

If more people start eating cereal for breakfast, the following things will happen. Some people will use soy milk or other milk substitutes, but the vast majority of people will use milk on their cereal. As a consequence, the demand for milk will increase if more people start eating cereal for breakfast. If it is assumed that there is no slack demand in the milk industry, then the suppliers of milk will not be able to increase supply right away. They will instead be constrained by the need to buy cows and equipment. Thus, in the short-run, the demand for milk will rise and the supply of milk would not. If we assume that the market for milk is not regulated (in many countries it is heavily regulated, with price floors and other constraints) then an increase in demand without a corresponding increase in supply will result in an increase in price. This will increase profits to producers, encouraging more producers to enter the industry (or existing producers to add capacity) and this will increase the long-run supply of milk in the economy.

b. If there is a mad cow epidemic, it should be expected that demand for milk would decrease. Consumers would either cut back on milk consumption, eliminate it altogether, or seek out substitutes. The quantity of milk demanded would decline in the short run. In the short run, producers would not be able to reduce production immediately. The reason for this is that investments in cattle would already have been made. With decreased quantity demanded and no change in supply, there would be a short-run surplus of milk. This issue would be compounded by the fact that in the event of a mad cow outbreak, other nations would close their borders to American milk. This would mean that producers would not be able to sell milk anywhere else. The result would be a glut of milk on the market, and the consequence of this is that prices would have to fall in order to producers to sell all of the milk they made. In the long-run, the combination of low demand and low prices would force many producers out of the market. Thus, in the long-run, the quantity of milk supplied in the market would decline.

c. If the price of milk increases, the quantity demanded with decrease. However, milk is a staple product and for most people it is not easily substituted. As a result, the demand for milk is not going to fall that far even with a price increase. Under this scenario, the quantity demanded will only fall a short way. Producers are likely going to see a net increase in profit. They will sell a slightly lower amount of milk and make small adjustments to their supply as a result, but they will earn more on each gallon of milk produced and therefore will see total profits rise.

d. If the government implements a price ceiling on milk, one assumes this would be so that consumers could be able to afford milk. However, the costs associated with producing milk would not be subject to price ceilings. In the short-run, if the price ceiling is halfway reasonable, there will not be much change in the milk market. Consumers will demand the same as before, producers will produce the same as before. There will come a point in the future, however, when the price of milk hits that price ceiling. Producers will see their profits reduced, because as their costs increase their ability to recoup those cost increases no longer exists. Profits for milk producers will decrease under this scenario, and over the long-run some producers will leave the market. The producers that remain will be those that can produce efficiently, and therefore have the lowest per-gallon cost of production. The total supply of milk might remain the same, because the remaining high-efficiency producers are likely to be able to earn profits at this level of output. In the long-run, however, lower prices are going to sustain the quantity of milk demanded at higher than equilibrium levels, and the profits available to producers at lower than equilibrium levels. Producers, in their efforts to control costs, are going to reach a point of diminishing returns on those efforts. The result of this is that the market for milk will eventually become so distorted by the price ceiling that the government is forced to raise the price ceiling in order to ensure that there are producers remaining in the market. The government will have created a situation where to simply maintain the milk market requires active management.

2. There are several factors that contribute to the price elasticity of demand. One factor is the availability of substitutes. For milk, there are many substitutes available. Another factor, directly related, is the propensity to substitute. For most consumers, there is a relatively low propensity to substitute milk for other products. However, as milk alternatives become more mainstream, the propensity to substitute is likely going to increase over time.

Another factor that affects elasticity is how important the product is. For many people, milk is an essential part of their diet, if not directly than in the form of other dairy products like cheese, butter, yoghurt or ice cream. As such, milk is likely to have a low level of elasticity because people will be hesitant to reduce consumption of these staple products. A fourth factor is the cost of the product relative to the consumer's total budget. In general, products that represent a minor portion of the budget are less likely to experience high level of elasticity. If the price of milk increases by 10%, that might only be an increase of 30 cents per gallon, so maybe 30-60 cents per week, whereas if the price of gas rises 10%, that could mean a similar increase per gallon, but translates to $3-$6 per week, a much more significant difference.

3. The demand for milk is price inelastic. Milk is a staple product that for most consumers represents a small portion of their total budget. While substitutes are readily available, the propensity to substitute is low, so that consumers are likely to absorb increases in the price of milk without adjusting their consumption. If the demand for milk changes at a lower rate than the price for milk, that implies that the demand for milk is price inelastic.