South-Western College Publishing - Economics  
Drought Dampens Hay Supply and Cattle Prices
Subject Comparative Statics
Topic Perfect Competition
Key Words Price, Auctions, Cost
News Story

1999 has seen a major drought in New England, the Middle Atlantic states and the eastern Corn Belt. The drought is causing the availability of hay to decrease and its price to increase. For example, a roll of hay would normally cost $10 to $12, but is now $15 to $20. Some cattle farmers are responding by selling their beef and dairy herds. Auctions are experiencing significant increases in the volume of cows bought and sold. Cows that would have sold for $650 to $700 are selling for under $400 each. The meatpackers know that the farmers have to sell.

The problem may worsen as winter approaches and hay is needed. Some farmers say that they will have to sell their livestock next year, if not this year.

Consumers are not likely to notice the effects of the drought if their grocery store buys produce and milk on a national basis. Other areas have had plentiful harvests and milk production in California and the upper Midwest has not been affected.

(Updated October 1, 1999)

Questions
1. The market for milk can be assumed to approximate perfect competition. Explain why this is a reasonable assumption.
2. Draw a supply and demand diagram of the milk industry and the equilibrium price and quantity. At the side, draw a diagram of a representative farm which is breaking even, showing the average and marginal revenue curve and the marginal and average cost curves.
  a)The drought has increased the price of hay, an input into the milk production process. Show the effect of this on the industry and for a representative farmer in a drought-affected area. Mark the new equilibrium price and output on each diagram and shows what happens to the profitability of the farmer.
  b)Explain why the price of milk increases less than the costs of the milk producer.
  c)If this situation persists, what would you expect to happen in the long run? Is your expectation being borne out by the news story?
3. Now consider the market for beef. Assume that it also approximates perfect competition. Begin by drawing diagrams for the beef industry and a representative meatpacker who is breaking even.
  a)The drought has reduced the price of cattle at auction. Illustrate the effect of this change in the price of an input to meat production on the industry and the representative meatpacker. Mark the new equilibrium price and output on each diagram and the effect on the profits of the meatpacker.
  b)Why is the change in the price of meat different from the change in costs?
  c)If this situation continues into the long run, what will happen? Illustrate your answer on your diagrams.
Source Associated Press (no author), "Drought forces cattle farmers to sell," St. Petersburg Times, August 22, 1999.

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