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1. a.) Highlights of scientific studies in an advertising campaign that find drinking milk can help reduce weight gain. The campaign will positively affect both the price and the quantity demanded, as a result more consumers will demand for large quantities of milk. High demand will cause a shortage of milk supply, therefore the quantity supplied will be insufficient, and this will result in the increase of the market prices for milk (Doherty, 2007).
b.) presence of a mad cow disease epidemic.
In this case, the consumers will refrain from milk consumption causing a decrease in the quantity demanded. This will result to surplus milk being produced and consequently lead to a fall in the price of milk.
c.) A decrease in the price of milk.
A decrease in the price of milk implies that the consumers will have high purchasing power; they will probably buy more of the milk. As it is explained in (Mankiw, 1998). Due to the low prices of milk the producers will be discouraged due to the accompanied expenses of production; as a result there will be a decrease in the quantity supplied.
d.) The government decides to implement a price ceiling on milk.
Government interventions always have a very significant effect on supply of any commodity. If the Government sets the price of a commodity to a value which is below the market-clearing level, then the quantity that the producers are willing to supply will be less as compared to the quantity that consumers will be willing to purchase. Consequently, the extent of the excess demand that is implied by this kind of response will directly depend on relative elasticity’s that exist with respect to the demand and supply. In case both the supply and the demand variables are elastic, then the price ceiling will create a shortage that is larger than when both are inelastic. Other factors such as the willingness of the consumers to more milk and the farmers’ ability to change the sizes of their herds and to produce less will also determine these elasticity’s and influence the governments regulation pattern and hence magnitude of excess demand (Arnold, 2007).
As Rosen, (2005). Explains, the governments price will result in the situations of excess demand where some producers will be unable to incur the expenses that are associated the production. In case the government price ceiling impacts negatively to consumers of milk, then those whose demands cannot be met will possibly attempt to purchase the substitutes, therefore increasing the demand for the milk substitutes, a phenomena leads to the rise in the prices of the substitutes.
2. The advantages and disadvantages to price controls
The incentive to minimizing of the cost re-emerges due to the regulatory link that is created between the costs and the ceiling prices.
The connection between the profits and rate base is broken.
The Price ceilings on the monopoly products can help in the prevention of the predatory pricing on the competitive services. This is necessary when the regulated and the competitive products are placed in different baskets for the purposes of formulation.
The farmer is usually the residual claimant of the surplus below the cap; therefore it has the incentive of minimizing costs. This has an implication that it also has the incentive of lowering the service quality, for any decrease in the quality it is equivalent to an increase in the price.
The incentive that is associated with the predatory pricing persists in case both the competitive and the regulated services are subjected to a similar X-factor and specifically if the firm exhibits the joint costs.
The Implementation of the price caps especially in the context of the informational asymmetries is complicated.
Price-cap regulation has no obligation to the publication rates of return, and therefore they have greater discretion, which also entails a greater potential in capturing of the regulatory process of the government.
In case when there is lack specific obligation to serving all customers of the monopolized products, then the regulation process may lack the incentive to serve the categories of the customers with the highest costs or those who are less willing to pay. (Colander, 2008).
3. Milk in this case has elastic type of elasticity. This is due to the responsiveness of the consumers to the changes in the prices of milk, which has direct impact on the supply and demand of milk.
According to (Harris, 1958) elasticity of supply measures the magnitude of the responsiveness of the quantity that is supplied in relation to the changes in price, since the percentage change in the quantity supplied is induced by a small change in the price. Since the supply is usually increasing with the prices, then the price elasticity of the supply is usually positive.
Other elasticity’s are calculated for the non-price determinants of supply. For instance, a percentage change in the amount of goods supplied that is caused by a one percent increment in the price of related goods is an input elasticity of supply if the related goods are the inputs in the production process.
The significant determinants of elasticity include:
The availability of substitutes; Substitutes play the role of replacement thereby reducing the demand for the main product there by making the consumer to be non-responsive to the change of the prices.
The percentage of one’s budget that is spend on the product; The higher the percentage of the budget that is spend on the product, the more responsive the consumer is and vice versa.
Reaction time: The price elasticity supply coefficient is largely determined by how quickly producers can react to the price changes by increasing or decreasing the rate of production and the supply of goods to the market.
The Complexity of Production process: Elasticity depends mainly on the complexity that is associated with the production process. Milk production process is relatively simple. This is because the labor is largely unskilled and the production facilities are very cheap. There are no special structures that are needed. Therefore, the price elasticity supply for milk is elastic. Contrary to this, the price elasticity supply for other production process facilities such as the types of milking machine is relatively inelastic. Machine milking of the cows is a simple process which requires very specialized equipments, some partly skilled laborers, and very large supplier’s network to reduce storage costs (Carley, 1968)
Consumers’ response time: The more the time that a consumer takes to respond to the price changes the more elastic the supply is. For example, a milk consumer cannot immediately respond to the increase in the prices of dairy cow feeds as compared to the price of milk.
Excess capacity: A milk producer who has excess capacity in the production units can quickly respond to the changes in the price of his market with the assumptions that the variable factors are readily available which is advantageous.
The Inventories: A milk producer with a constant supply of milk or who has the available storage capacity can quickly respond to the price changes.
4. The total revenue decreases with the increase in the price of milk; this is attributed to the elasticity of the dairy industry’s products. The consumers of dairy products, specifically milk in this case are very responsive to the changes in milk prices. Increase in the price of milk means that there will be a shift on the demand curve to the right; this is because the consumers will tend to reduce the rate of milk consumption to curb on the costs. This will cause a decrease on the total revenues due to the low demand for milk. (Tucker, 2008)
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