Macro Economic Affects on Rice

Assuming a competitive market, explain with the aid of a market model how the price and quantity of rice is established

In a competitive market, the optimum price of rice is established at market equilibrium. The quantity willingly demanded by consumers at a specific price is willingly supplied by producers at that price (O'Sullivan 2003). The method to which equilibrium quantity demanded and supplied is discovered for rice can be explained by the price mechanism and the supply and demand model. Scarce economic resources are rationed to the wants and needs of the market (Kolsen 1970). Ceteris paribus, resources from producers are rationed according to what producers are willing and able to supply at a given price (Callan 2007). Consumer resources are rationed according to what they are willing and able to purchase at a given price (Callan 2007). The rationing of resources by producers and consumers in purchasing and supplying rice establishes how much will be demanded and supplied at each specific price in the model. The rationing of finite resources also illustrates the opportunity cost that must be forgone to purchase the specific quantity at that price.

How equilibrium is discovered can be explained through the movement in and out of surpluses and shortages. At any price above the supply and demand curve intersection, a market surplus has occurred (Blackorby 1993), labelled "surplus" on figure 1. In figure 1, the quantity willingly and able to be supplied at P5 by producers (Q=60) is greater than what consumers are willing and able to purchase at P5 (Q=10) (Blackorby 1993). This encourages consumers to evaluate substitutes as they may be a cheaper option. The increased competition forces producers to lower prices to remain competitive. Due to the downward pressure on price the surplus will reduce until stabilised at what is the equilibrium price SQ=DQ. Likewise, in figure 1, if P=1 the quantity willingly and able to be purchased by consumers (Q=53) is greater than the quantity willingly and able to be supplied by producers (Q=10), a shortage has occurred. At market shortage, consumers must compete for limited supplies compelling firms to raise prices from P1 effectively causing an upward pressure until price stabilises at the equilibrium price SQ=DQ.

Figure 1 (Fung 2004)

Explain the determinants of the price elasticity of demand as they apply to the demand for rice and comment how the price ceiling will impact the value of the suppliers revenue

Price elasticity of demand is defined as the relationship between percentage changes in quantity demanded to the percentage change in price (Hirshleifer 2005). Consumption decisions for rice made by Sri Lankan consumers will determine the relative rice price elasticity of demand. In a competitive market the availability and price of substitutes determines the consumption decisions thus elasticity of demand for a product. If substitutes are largely available, minor price movements are likely to dramatically impact the quantity demanded by consumers (McAuliffe 1981). Demand for rice in the Sri Lankan market would be relative to its substitutability. Rice is a staple ingredient of traditional Sri Lankan cuisine and is consumed daily (Wijewardene 2010). Considering the -0.8 PED rice has in neighbouring Bangladesh (Perloff 2008), consumers in Sri landka are unlikely to change their preference to grains or wheat inferring rice to be being relatively inelastic. The reaction to the cost of rice as percentage of consumer resources (Y) is unlikely to affect the elasticity of demand. The upward pressures on price representing a substantial proportion of income for consumers will be unlikely lead to consumers seeking substitutes or foregoing rice completely. Rice is a stable product in Sri Lanka, it would be considered a necessity to consumers thus would be relatively inelastic.

A price ceiling refers to a government imposed limit on prices of a product. If the price ceiling is set below current market equilibrium, the price per unit is diminished. Assuming the quantity rice for a season is finite, the initial impact of this price ceiling will be a reduction in total revenue expected