BB106 Economic Principles

Table of Contents

Question:

Students will be asked to answer four questions that are based on the article.

Assuming that tomatoes are sold in a competitive market, what other factors have contributed to the increase in tomato prices in Australia?

Include appropriately labeled demand and supply curves in your answer to help explain how you reached the new equilibrium price and output.

Explain the concept of demand elasticity.

Discuss the price elasticity for tomatoes using appropriately labeled demand and supply curves.

c. Based on your answers in part b, illustrate hypothetically what should the rising tomato price have on the total revenue from the wholesale tomatoes market.

d. Explain the various strategies the government should use to maintain a long-term supply of tomatoes, considering that some tomato farmers may leave the industry.

To support your answer, use graphs.

Discuss the benefits and drawbacks of the strategies that you have chosen.

Answer:

The tomato market is highly competitive and therefore the sellers on the market are price takers rather than price makers.

The price of the tomato would not change based on any seller’s economic decisions.

The buyers would assume that they have complete knowledge, so the sellers would have the market price to be accepted (Mankiw 2014).

Other than the cyclone, the price rise in tomato could be attributed to these factors.

Change in preference of consumers

The increase in tomato prices could be due to a change in consumer preferences.

The availability of higher quality tomato varieties and the perceived health benefits of tomato consumption may be two reasons for the rise in tomato consumption.

Evidence suggests that Australia has seen a rise in demand for sweet tomatoes over the past decade (FreshPlaza nd).

This causes the demand curve to shift upward, causing an increase of the tomato’s price in the short-term. However, increased supply may allow for a longer time.

In the short-term, however, this could lead to a higher price, as shown in the graph (Nicholson & Snyder 2011, 2011).

Evidently, because of a shift in the demand curve the price has risen to P2, which leads to higher profits for producers.

Arable Land is not readily available

The increased price of tomato is also due to the fact that there is not enough supply to meet the growing demand in Australia. This is because the land available for tomato is very limited in some parts of Australia.

This has had the net effect that grasslands have been converted to agricultural land, but this has not been able keep up with rising demand.

The productivity of tomato has also been affected by climate change, although less cultivation is starting to increase its production (Bryce 2017, 2017).

Below is the graphical representation below of an ideal situation where rising demand is balanced by increasing supply (Mankiw 2014).

The supply of tomatoes has not kept up with the demand, so there is an increase to the price.

The percentage change in quantity that is caused by price changes, called demand elasticity.

The demand for the underlying product will be elastic if the demand elasticity exceeds 1 in magnitude.

A demand elasticity less than 1 in magnitude, on the other hand, indicates an inelastic market for the underlying products.

Normal goods have a negative demand elasticity because price and quantity are inextricably related.

For inferior goods, however, the demand elasticity is positive.

Below are the graphs that indicate elastic and inelastic demands (Nicholson & Snyder 2011, 2011).

A host of factors affect the demand elasticity for a good, including income levels, availability and cost of substitutes, budget contribution, and the nature of the product.

Because tomato is an Australian staple food, the demand elasticity for tomatoes is likely to be low.

There are few cheaper options available, especially considering the health benefits and taste of tomatoes.

It is possible that people will switch to cheaper varieties of tomatoes if the price goes up.

This is particularly true in the restaurant and food industry.

A small contribution of tomato to the monthly household budget would mean that consumers wouldn’t be affected by price increases.

The above factors may lead to the conclusion that tomato demand is not elastic with a demand elasticity below 1.

Consider that tomatoes have a price elasticity of -0.6.

Let’s now try to raise the tomato price to see the effect on the revenue.

Original tomato price = $ 4/kg

New tomato price = $ 6 per kilogram

Therefore, the percentage change in tomato price = [(6-4/4)]*100 = 50

Demand Elasticity = % change of quantity/% change price

We substitute the values available to get

-0.6*50% = % increase in quantity

Therefore, the change in tomato quantity is -30%

Let’s assume that 100 million tonnes of tomatoes were consumed in the initial demand.

Increased demand for tomatoes = 100* (1-0.30) = 70,000,000 kg

Original Revenue from Tomato = Original Prices * Original Quantity Required = 4*100 = $400 million

Revised Revenue from Tomato = Revised Prices * Revised Quantity Required = 6*70 = $ 42 million

The above calculation shows that because tomato demand is not elastic, revenue would rise due to higher prices.

There is a possibility that farmers will migrate to other crops to avoid the growing damage from climate change.

Below are some examples of strategies the government could use to ensure a long-term supply of tomatoes.

Subsided premiums for tomato farmers must be offered, especially in areas with high production and vulnerable areas.

This is necessary to reduce losses for farmers in the event of a cyclone or other natural disasters.

This strategy has one drawback: it increases the fiscal burden on the government, especially when the mining sector is down.

This can be seen in the graph below (Nicholson & Snyder 2011, 2011).

This would result in a higher supply and lower prices over the long-term, it is obvious.

Technology can be used to increase supply.

Hydroponic farming, which is based on sunlight and seawater, has been a technological breakthrough. It does away with the need for fertile soil.

This allows for the production of tomatoes in areas that are not suitable for it (Bryce 2017, 2017).

To ensure long-term supply, the government might consider offering subsidies for this technology.

Tax breaks might also be available.

However, this could lead to an increase in fiscal burden that the economy is not ready for.

This can be seen in the graph below.

This would result in a higher supply and lower prices over the long-term, it is obvious.

Refer to

London: Worth Publishers

Snyder, C. and Nicholson W. (2011), Fundamentals of Microeconomics (11th edition).

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