Markets, Equilibrium, and Prices

How do you know when the price is “right”?

6.1 Introduction

If you were to drive into Albion, Nebraska, from the south or west, you might see swelling, billowing clouds of steam from the ethanol plant on the edge of town. Ethanol, which in the United States is made primarily from corn, is a biofuel-a fuel made from recently living organisms or their by-products. Ethanol is in growing demand as a gasoline additive to help meet energy needs.

Ethanol, and the corn it is made from, is one of the main reasons that Albion, a farm town of 2,000 people in central Nebraska, is booming. On a hillside overlooking Albion, huge new homes are going lip. In town, residents are renovating and expanding their houses.

“There’s a buzz in Albion,” says Brad Beckwith, a corn and soybean farmer. He and farmers like him are reaping profits for the first time in decades. With the demand for corn increasing, grain prices are skyrocketing to historic levels.

How does the rising demand for corn affect consumers? Think about all the foods you eat that are made from corn, such as corn flakes, corn muffins, and tortillas. Soda, candy, and hundreds of other processed foods contain high fructose corn syrup. And then there is popcorn. The corn used for popcorn is different from that used in ethanol, and popcorn producers have to pay farmers more to plant it instead of corn for ethanol. Higher prices for corn mean increased prices for these foods at the grocery store.

Ranchers also pay more for corn, which they use to feed cattle, pigs, and chicken. The higher cost of feeding livestock is then passed on to consumers in the form of higher prices for beef, pork, and chicken.

Of course, agricultural markets can be unstable, with swings in supply and demand that lead to rising and falling prices. If ethanol does not prove to be as efficient a fuel as people hope, the demand for corn may slow. In fact, ethanol production in Albion has recently become volatile. Valero, the company running the ethanol plant, temporarily shut down production in Albion multiple times due to high corn prices. Many factors contribute to corn prices, but droughts can significantly reduce supply, resulting in much higher prices.

There will always be factors affecting the prices of the products you buy. In this chapter, you will learn what these factors are. You will see how supply and demand interact to set prices and how changes in supply and demand can cause prices to change. This chapter will help you understand what “the price is right” really means.

Next Reading: 6.2 (What Happens When Demand Meets Supply?)