Answer to Question #130208 in Microeconomics for Shahmir Yousaf

Question

Growing cotton requires large amounts of water and fertilizers. In 2014, Kazakhstan, a major producer of cotton, introduced a $10 levy for every 1000 gallons of water used for agricultural purposes. At the same time the price of natural gas, a major component of ammonia based fertilizers fell by 50%. Additionally, advances in the production of Rayon, a substitute for cotton, led to a 15% decrease in the price of Rayon. In the market for cotton, explain what happened to the equilibrium price and quantity.

Answer 1

To determine the equilibrium price and quantity, we will follow the following steps;

i) Draw the graph with the initial supply and demand curves. Label the initial equilibrium price and quantity for the cotton market.

ii) Decide whether the economic change we are analyzing affects demand or supply. In other words, does the events occurring refer to something in the list of demand factors or supply factors?

iii) Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram. In other words, does the events increase or decrease the amount consumers want to buy or producers want to sell?

iv) Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.

$$Solution$$

i) The graph shows the initial equilibrium price and quantity for cotton before considering it's compliments of water and fertilizer. The point $E$ shows the equilibrium price.

The economic changes taking place involves acquisition of water and fertilizer for production of cotton, and will be considered as supply factors. These events will lead to rightward shift of the supply curve because a major component of fertilizer fell by 50% and also they introduced a levy of  $10. The new new equilibrium will be as shown below.

The new equilibrium is $E_2$ and also the price shifts from $P_1 to P_2$ with a corresponding quantity supplied increasing from $Q_1\ to\ Q_2$