Sunday, January 24, 2010

Differing Effect on Demand and Supply

In Principles of Microeconomics I spend a fair amount of time on the Demand and Supply model of price determination. During this time I try to explain how various exogenous variables can affect the demand and/or supply of a good or service. The difficulty that many have is trying to figure out how whether a change in a variable affects either the demand or the supply of a good or service. In an effort to make this point more concrete, I want to summarize this article from the Financial Times on the impact that a cold winter has on both oil prices and corn prices.

At the begining of the article linked above, we see that oil prices are rising due to colder weather (lower winter tempertures). This is a great example of how a change in one exogenous variable (colder weather) affects the demand curve for heating oil. Here consumers faced with colder weather will use more heating oil (i.e. demand more heating oil) at existing prices to heat their homes. Given this increase in demand, the demand for heating oil - in terms of the demand model - shifts to the right. With no change in supply, the price of heating oil rises, which is what the article points out.

At the same time we see that a major winter storm is delaying corn harvest production and reducing the timely supply of corn due to transportation delays and disruptions. This from the models perspective is shifting the supply of corn to the left, and with no change in the demand for corn, results in an increase in the price of corn.

How the exogeneous variable (lower winter temperatures or a major winter storm) affects the demand and supply model depends on which side of the market consumers (demand) or producers (supply) is affected. Once you figure this out then you need to determine whether the change is increasing (shifting to the right) or decreasing (shifting to the left) the appropriate curve.

No comments: