Cyclone Larry destroyed approximately $300 worth bananas crop which is 90% of the production at Queensland. The fall in supply and unchanged demand will result in a shift of the supply curve to the left resulting in an increase of the equilibrium price. The demand will stay the same however there might be a slight fall in the demand at a later stage due to increased prices but in the short run demand remains same. A fall sharp in supply means quantity supplied will be less than the quantity demanded of bananas leading to an increase in price as shown in the graph below.
The graph shows the original quantity demanded (D) and supplied (S) with the intersection as the market equilibrium at price P1 and quantity Q1, the inward shift of the supply curve to the left with new quantity supplied after the cyclone with a new intersection point representing increased market equilibrium at price P’ and quantity Q’. 2a. Determinants of price elasticity of bananas The following are some of the factors that affect the elasticity of demand for bananas: Substitutability: Since bananas have a large number of substitutes like other fruits, it is inelastic in demand.
Proportion of income: Price elasticity of low priced goods like bananas is low. This means that the demand for bananas grow slowly as income increases as it is very small proportion of the total income earned. Necessity: The greater the good is considered a luxury the more elastic it is. Banana is a necessity and is therefore inelastic in nature. Time: Consumers need time to adjust to changes in price. In the short run there will no change in demand for bananas but in the long run, consumers might reduce their purchases and switch to other substitutes. 2b.
Price Elasticity of Demand before and after Cyclone Larry Cyclone Larry will result in a change in price and a change in the quantity demanded. The price elasticity of demand can be calculated as follows: Price elasticity of demand = Percentage change in quantity demanded Percentage change in price Change in price and quantity will not change the percentage change in either the price or the quantity. However quantity demanded in units and price demanded in dollars will be changed. This will not change the price elasticity of demand. 2c. Impact on West Australian Producer’s Revenue
There will be a shortage in the market for bananas due to the cyclone and so only West Australian production which comprises of 5% of the total production will be available in the market. No import of bananas is allowed due to biosecurity risks. Since bananas are inelastic in nature the change in quantity demanded is less responsive to changes in price. Total revenue (quantity demanded*price) of West Australian producer’s revenue will increase. A good year can reduce farm income as the quantity demanded remains same, supply increases and so the price goes down. 3a. Government Intervention
Governments mostly put minimum price floors and restrict imports of agricultural products to support the farmers. Since the elasticity of these products is low, an increase in price raises the total revenue of the farmers. A good bumper year results in an increase in the quantity demanded which leads to a fall in price hence a fall in the revenue earned by farmers. A fall in the production of agricultural products will increase price and therefore the revenue for the West Australian farmers. Farmers in Queensland will their little production at high prices. The government can intervene by either setting price ceiling or floor.
Price Ceiling A price ceiling means that the price of bananas cannot exceed the maximum price set by the government. A price ceiling above the equilibrium price will have no effect, since equilibrium can be attained. A price ceiling below the new equilibrium will be effective. But it will not be beneficial for farmers as they will be forced to sell at or below the maximum price ceiling. This will result in excess demand. The graph below shows the effect of establishing a price ceiling below the market price. Price Floor A minimum price floor means that the banana growers cannot sell at a price below the price set by the government.
Bananas will be sold at or above the minimum price established. A price floor that is set at or below equilibrium has no effect because equilibrium can be attained. However, if the price floor is set above equilibrium price, it will be effective. This will be beneficial for the growers but not for the consumers. There will be an excess supply. The following graph shows establishment of a price floor above the market price. 3b. Consequences of Price Floor As shown in the graph above a price floor will result in higher prices. This will be profitable for the banana growers but not for the consumers.
In this case the quantity supplied will exceed quantity demanded. The excess demand will have to be taken care of. The government will have to step in and buy the excess quantity supplied and either store it in the warehouse which will not be feasible since banana is a perishable good or dispose it off. 3c. Should the Government Intervention be supported? The government can step in and subsidize bananas and help the unemployed workers by finding an alternate job for the seven months till new banana crops grow. A price ceiling above the equilibrium should not be supported as it will create the potential for black market.
Banana will be bought at the controlled price and sold at the market price. The government can support a price floor which would result in excess supply which can be bought by the government and sold at a lower price. References Samuelson A. , Nordhaus D. (1989). Economics. McGraw-Hill http://www. smh. com. au/news/national/thousands-of-jobs-gone-with bananas/2006/03/20/1142703270076. html Illustrations www. netmba. com/econ/micro/demand/elasticity/price http://www. smh. com. au/news/national/thousands-of-jobs-gone-with bananas/2006/03/20/1142703270076. html