2. The average export price of cotton during December 2017 was 60 cents per poun

Question

2. The average export price of cotton during December 2017 was 60 cents per pound. Suppose the supply of cotton during the fall of 2018 is expected to decrease by 10% while the demand for cotton is expected to increase by 20%. The elasticity of demand for and supply of cotton are estimated to be-0.80 and 1.50, respectively. Calculate the estimated price of cotton for this season. (Hint: According to equilibrium displacement model, percentage change in price can be calculated as % P IS,-S]/[E,-Ed], where Ed and E, are the elasticity of demand and supply, and S, and S, represents exogenous shift in demand and supply, respectively) S demand and supply, respectively.) (5 points)

Explanation / Answer

As per the equilibrium displacement model,

% Change in price = (% Change in demand - % Change in supply) / (Elasticity of supply - Elasticity of demand)

= [20% - (-10%)] / [1.5 - (-0.8)]

= (20% + 10%) / (1.5 + 0.8)

= 30% / 2.3

= 13.04%

New estimated price = 60 cents x 1.1304 = 67.82 cents

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