Supply and Demand: The Case of Milk

Milk prices are soaring. Millions of consumers all over the world buy milk products on a daily basis and are not willing to give them up. Climate change, competition among biofuel producers, trade policies and other factors drive global milk prices and turn milk into one of the most expensive food products (Arnold, 2007). “Cows are fed with corn and as more corn is diverted to energy production, feed costs and dairy farmers in turn pass those costs up the food chain” (Doherty, 2007).

Simultaneously, international milk producers fail to cope with the growing demand for milk. The demand for milk products is at all-time high (Arnold, 2007). The roaring global economy and rising incomes in India, China, and Latin America make the task of producing enough milk extremely challenging and virtually unachievable (Arnold, 2007).

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Milk products are similar to gasoline: consumers cannot give them up even when the price grows unbearable (Doherty, 2007). Financial experts predict that, as the price of milk increases, the demand for milk products is likely to remain unchanged (Doherty, 2007).

Apparently, the elasticity of demand for milk and milk products is extremely low. Put simply, the global demand for milk and milk products is not responsive to changes in milk prices. It should be noted, that elasticity is the central measure of market responsiveness in microeconomics (Baumol & Blinder, 2008).

The main determinants of demand elasticity include the nature of the good, availability of substitutes, household budgets, and passage of time (Rittenberg & Tregarthen, 2011). The nature of the good is directly related to demand elasticity: necessities like food products tend to have inelastic demand curves (Baumol & Blinder, 2008).

This is particularly the case of milk, since many consumers perceive milk as the fundamental ingredient of their diets and large food manufacturers use milk in their products. Milk does not have close substitutes, and substitutability remains one of the main factors of demand elasticity in microeconomics (Baumol & Blinder, 2008). Given that the demand for milk is highly inelastic, the demand curve for milk will look as follows:

Fig.1. Inelastic demand for milk and milk products.

Thousands of consumers spend their budgets on milk, because they believe it to be useful for their health. Consumers take the usefulness of milk for granted (Doherty, 2007). They treat milk as an excellent source of cheap proteins (Doherty, 2007). Therefore, if an advertising campaign spreads the message that milk helps to reduce weight, the quantity demanded will soar.

Fig.2. Changes in quantity demanded and price after the advertising campaign.

The price of milk in the short-term period will remain unchanged, as the growing demand for milk products does not reduce the costs of milk production.

In short-term periods farmers will also experience the shortage of supply. In the long run, the price of milk will increase to create new market equilibrium.

A mad cow disease epidemic will reduce the amount of milk in the market. The quantity demanded will drop, since customers will not be willing to purchase milk products and get infected. The supply curve will move to the left together with the demand curve. The price of milk will remain unchanged.

Changes in the price of milk will cause no shifts in the demand curve. However, the quantity demanded will change. Consumers will want to purchase more milk at a lower price. An increase in the demand for milk products will manifest through movements along the demand curve.

However, as the demand for milk increases, most farmers will fail to supply enough milk to the market, followed by the shortage of milk products. Consequentially, changes in the price of milk may move the supply curve to the left: possibly, milk manufacturers will have to adopt new technologies to meet the growing demand for milk.

How the government price ceiling for milk affects the supply and demand of milk products depends on whether the ceiling price is below or above the market-determined equilibrium.

Actually, the government price ceiling for agricultural products is a frequent object of microeconomic analysis. The government is believed to produce heavy influences on the stability and equilibrium in the milk market. The government-imposed price ceiling above the market-established equilibrium price will have no effects on either the supply or demand of milk.

By contrast, the ceiling price below the market-established equilibrium will cause profound effects on the supply and demand of milk. Farmers will not be able to charge the market price for milk. Some suppliers may choose to leave the milk market. Reduced supply will cause the shortage of milk products in the market. Consumers will fail to meet their demand for milk and milk products.

Price control is one of the most controversial aspects of the market-government relationship. Government price ceilings reduce consumer prices, whereas price floors increase firms’ revenues and incomes (Economics Help, 2008).

Consumers believe that government price ceilings limit suppliers’ ambitions and make goods and service affordable. Government price ceilings alter the market equilibrium in the agricultural market. Price controls are associated with numerous disadvantages. First, government price ceilings lead to the shortage of goods in the market (Economics Help, 2008).

Second, government controls of minimum prices raise consumer prices and result in oversupply of products and production inefficiency (Economics Help, 2008). Given that milk does not have close substitutes and is considered a food necessity, its demand is inelastic. As a result, any increase in price for milk will inevitably lead to an increase in total revenues, as slight reductions in quantity demanded are a trifle, compared with the revenues earned from increased prices (Quick MBA, 2011).

Conclusion

Milk prices are soaring. More consumers are willing to have milk in their diets. Climate changes, new technologies, and increased consumer incomes make the task of producing enough milk virtually unachievable. The elasticity of demand for milk and milk products is extremely low. Put simply, the global demand for milk and milk products is not responsive to changes in milk prices.

Many consumers perceive milk as the fundamental ingredient of their diets and large food manufacturers use milk in their products. Milk does not have close substitutes, and substitutability remains one of the main factors of demand elasticity in microeconomics.

When an advertising campaign spreads the message that milk helps to reduce weight, the quantity demanded will soar. Changes in the price of milk will cause no shifts in the demand curve. Any increase in price for milk will inevitably lead to an increase in total revenues, as slight reductions in quantity demanded are a trifle compared with the revenues earned from increased prices.

References

Arnold, W. (2007). A thirst for milk bred by new wealth sends prices soaring. The New York Times. Retrieved from http://www.nytimes.com/2007/09/04/business/worldbusiness/04milk.html

Baumol, W.J. & Blinder, A.S. (2008). Microeconomics: Principles and policy. Boston: Cengage Learning.

Doherty, R.E. (2007). Milk demand stays strong despite high prices. Reuters. Retrieved from http://www.reuters.com/article/2007/06/20/us-milk-prices-idUSN2024940220070620

Economics Help. (2008). Price controls – advantages and disadvantages. Economics Help. Retrieved from http://www.economicshelp.org/blog/economics/price-controls-advantages-and-disadvantages/

Quick MBA. (2011). Price elasticity of demand. Quick MBA. Retrieved from
http://www.quickmba.com/econ/micro/elas/ped.shtml

Rittenberg, L. & Tregarthen, T. (2011). Principles of microeconomics. Flatworld Knowledge. Retrieved from http://www.flatworldknowledge.com/node/28279#web-28281