South-Western College Publishing - Economics  

Ice Cream in Distress
Subject Equilibrium
Topic Comparative Statics
Key Words Price, Supply, Subsidy, Consumers
News Story On the Chicago Mercantile Exchange, the price of a pound of Grade AA butter has risen 73 percent to $1.95 over the past year. As a result, wholesale prices are increasing sharply, and retail supermarket prices may rise from $2 to as much as $3 a pound. Blame has been placed on El Nino which caused Californian dairy farms to be waterlogged and the supply of milk to be reduced; subsidies which gave farmers incentives to export butter; and American consumers’ reversion to butterfat products such as cookies and desserts.

As a result, users of butterfat, such as premium ice cream makers like Dreyer and Ben & Jerry, are raising their prices. It is speculated that consumers may reduce their consumption of butter. They may switch to soybean-based margarine.

The diminution of the milk supply has also affected the market for cheese--the other product made from milk. Cheese makers are facing higher milk prices and are raising their own prices.
(Updated August 12, 1998)

Questions
  1. Draw a supply and demand diagram of the market for milk. Show the equilibrium price and quantity of milk.
    1. Illustrate the effect of El Nino on the equilibrium price and quantity.
    2. Why did you move the curve you did?
  2. Now draw a diagram of the U.S. market for butter. Mark the equilibrium price and quantity.
    1. What kind of good is milk in relation to butter? Which curve does a change in the price of milk affect? Show and explain the effect of the higher price of milk on the equilibrium price and quantity of butter.
    2. Export subsidies can be seen as an increase in the price of a substitute in production. Which curve is affected by this factor? How does it move? Illustrate on your diagram and show the implications for the equilibrium price and quantity of butter in the U.S. market.
    3. Consumer preferences have moved in favor of butter-using goods. Which curve shifts as a result? Show what happens to the equilibrium price and quantity on your diagram.
    4. It is speculated that consumers may reduce their consumption of butter. Does your analysis allow a more definite conclusion? Why or why not?
  3. Finally, draw a diagram of the market for cheese. Show the equilibrium price and quantity. Illustrate what happens to the equilibrium when milk prices rise and consumers desire to eat more cheese.
Source S. Kilman and R. Balu, “Butter Shortage Is Lifting Dairy Prices,” The Wall Street Journal, June 23, 1998.

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