Law of Demand and its relation to Food Prices

1.a)According to the law of demand, there exists an inverse relationship between the price of a commodity and the quantity demanded of the same, provided that the commodity is normal commodity. This is due to the fact that income, like any other resources in the economy, is limited and thus is scare, which leads to the presence of trade off between the choices of the consumers, such that his or her utility is maximized (Heakal 2015).

Food, like all other commodities are made up of resources, which are scarce and limited. Therefore, the law of demand is also applicable for food products in the economy. However, food being a necessary commodity, the demand for the same, though abides by the law of demand is comparatively inelastic (Atkinson and Stiglitz 2015).

b)Food, as a consumption good, can be a necessity good or a luxury one, depending upon the nature and price of the same. Depending upon the same, the substitution effects of the food products vary, with changes in the prices of the same. In general, food being normal necessity, the substitution is positive, that is with the increase in the prices of one type of food product, people tend to substitute the same with similar foods.

Example- With the increase in the prices of hamburger, price of hotdogs remaining the same, people will tend to substitute the former with the latter (Nicholson and Snyder 2014).

However, if the prices of all the food products as a whole increases, the price of other things remaining the same, the demand for food decreases but comparatively less as foods fall under the category. People tend to curtail other expenses in order to buy food as per their requirements, which can be explained with the help of the following diagram:

Figure 1: Price effect, income effect and substitution effect for normal commodities

(Source: As created by the author)

As can be seen from the above diagram, where food is denoted by X, in the horizontal axis and other commodities denoted by Y, in the vertical axis, the increase in the price of the food products, can be explained with the help of the Hicksian price and substitution effects. Due to the increase in the price, the budget lie rotates from AB0 to AB1. With the help of the income compensated budget line (Red dotted line) it can be seen that the substitution effect is of the amount X0’X1, which shows that with the increase in the price of the food products, the demand decreases from X0’ to X1.  

Substitution and Income Effects of Food Prices

c)The income effect, on the other hand, being a part of the total price effect, shows the change in demand of a certain commodity, due to the indirect change in the value of the income in one’s hand, due to the change in the price of the same. From the above figure, with the help of the compensated budget line, the changes can be seen due to the increase in the prices of food products. The prices of other things remaining constant, the reduction in the demand for food products, caused by the decrease in the real value of the income is to the extent of X0X0’ (Fisher and Shell 2014). Therefore, the income effect of the same is to the extent of X0X0’.

2.a)In the recent periods, the prices of land in the main metropolitan cities in Australia have been consistently increasing, which is especially true for cities like Darwin, Sydney and Melbourne. There are several reasons behind the same, which is elaborated in the following sections:

1) Increase in the population- With the increase in the economic prosperity of the country and expansion of commercial activities in the same, the population of the country has significantly increased. Huge immigration from other countries, both for job seeking and for the purpose of attaining higher education. This has created a huge demand for housing in the country, especially in the metropolitan cities, where the prospects and conveniences are considerably higher. Land being the base for such housings, the increased demand for land has led to the increase in the price of the same (Abc.net.au, 2017).

2) Residential Investment- With the concept of residential investment becoming more popular, investors as well as households, in the recent periods, view the same as an alternative form of investment and asset building. This has also resulted in increase in the demand for housing, which in turn has led to the hike in the price of the land.

3) Limited Availability- Given the land, like any other resources, is scarce; the availability of the same is limited, which in turn limits the supply to a certain extent. This, clubbed with the continuous increase in the demand has led to an even more increase in the price of the same (Cordato, R., 2013).

b)The above situation of increase in the price of the land resources in the metropolitan cities in Australia can be explained with the help of the following diagram:

Factors Driving Up Housing Prices in Australian Metropolitan Cities

Figure 2: Inelastic supply curve of land resources

(Source: As created by the author)

Land, being a scare natural resource, is limited in supply and cannot be produced. This gives the supply curve of land, especially in the metropolitan city, a vertical nature. On the other hand, with the continuous increase in the demand for residential assets, leads to huge increase in the price level of lands, the supply remaining the same, as can be seen from the above diagram (Crowe et al. 2013).

c)In the short run, the supply of land is perfectly inelastic in the metropolitan cities in Australia, which shows in the vertical supply curve. However, in the long run, the cities can increase their areas and occupy new lands in the surroundings, which now are considered to be suburb. This indicates that in the long run, the supply of land though vertical, can be shifted rightward.

Figure 3: Long run supply curve for land resources

(Source: As created by the author)

3.a)In economics, the term externality refers to the effects of consumption or production of certain commodity or service on those third party players who are not directly involved in the process of consumption or production of the same. These effects may be positive as well as negative with the externalities rising from the former ones being known as positive externalities while the those arising from the latter being known as negative externalities.

In this context, the ban or potential ban on the usage of plastic bags and containers, as has been declared by the governing authorities of different areas of Australia, can be explained. The usage of plastics has several severe adverse implications on the overall environmental conditions of the society:

1. i)Though the cost of production of these bags and containers are less, however, these plastic containers are mostly not recyclable, which increases the waste deposition hugely thereby increasing the social cost.
2. ii)Most of these plastic products are non-biodegradable, which hampers the environment and their disposal becomes an issue of concern as most of the times they are found to clog water resources and pollute the same, having negative implications on both the human lives as well as overall environment and living conditions of other animals and aquatic life (Nicholson and Snyder 2014).

iii) Nearly 80% of all the plastic bags and containers cannot be reused and they need to be disposed. Most of the time due to the huge cost of proper disposal of the same, they are improperly disposed, which leads to health hazards for the residents.

The negative impacts of usage of plastic bags and containers lead to a situation where the social cost of production of the same is greater than the private cost. These give rise negative externalities, which can be eliminated or reduced by the following methods:

1. i)Ban on production and usage of plastic containers can be an efficient way to curb the negative externalities arising due to the same (Cordato 2013).
2. ii)Usage of alternative and biodegradable substances in place of the same can help in cutting the long term social costs of plastic bags and containers usage.

iii) The loss in welfare of the society, due to the usage of the plastic bags and containers can be explained with the help of the following diagram:

Figure 4: Social welfare loss due to usage of plastic bags

(Source: Cordato 2013)

From the above diagram, it can be seen that if the production of plastic materials are left in the hands of the free market, then the market will come at equilibrium at the point A, where the marginal social benefit from consumption of the commodities is equal to the marginal private cost of production of the same (Crowe et al. 2013). However, the marginal social cost, which includes the costs discussed above, if taken into account, then is seen to be greater than the marginal private cost. If the production needs to be socially optimum, then the equilibrium is required to be at the pint B, where PMB is equal to the MSC and not the MPC. If that is not done then the welfare loss due to the production and usage of plastic bags and containers is shown with the help of the shaded region in the above figure.

References 

Abc.net.au (2017). Home prices keep rising led by Sydney surge. [online] ABC News. Available at: https://www.abc.net.au/news/2015-04-01/home-prices-keep-rising-led-by-sydney-surge/6363916 [Accessed 24 Dec. 2017].

Atkinson, A.B. and Stiglitz, J.E., 2015. Lectures on public economics. Princeton University Press.

Cordato, R., 2013. Welfare economics and externalities in an open ended universe: A Modern Austrian Perspective. Springer Science & Business Media.

Crowe, C., Dell’Ariccia, G., Igan, D. and Rabanal, P., 2013. How to deal with real estate booms: Lessons from country experiences. Journal of Financial Stability, 9(3), pp.300-319.

Fisher, F.M. and Shell, K., 2014. The Economic Theory of Price Indices: Two Essays on the Effects of Taste, Quality, and Technological Change. Academic Press.

Heakal, R., 2015. Economics basics: Supply and demand. Investopedia. accessed September, 28.

Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application. Cengage Learning