Earlier this week, I raised the following question in price theory:
The government has a binding price cap on the orange. But it does not impose a price cap on orange juice. What happens to the price of orange juice after the ceiling is stabbed at orange price? (Suppose an orange competitive market.) Show your work.
I said I’d post my answer. He also said he would post a supply and demand diagram. However, the diagram has become complicated because there is both supply and demand for orange and supply and demand for orange juice. And, of course, orange is an important input to orange juice, but oranges are also available at retail stores.
The good news is that you don’t need to show the demand and super days of orange juice to get the answer. What is necessary is to pick up the orange binding ceiling dropping the number of oranges produced. That drives the outcome. The result – a decrease in the number of oranges produced and sold – can show on-demand and orange supplemental curves, but there is no need to do so. (I let my students do that.)
The economy of binding price management, whether it’s the price ceiling or the price range, the way I put it in education over the last 15 years or so is that “a short side of the market dominates.” When the price is at the upper limit, the master sold in the market is stronger than when there is no upper limit. The supply side controls – you can’t buy anything that no one is selling. For price floors, the amount sold on the market is stronger than if there is no price floor. The demand side controls – you can’t sell things that no one buys.
Now, back to the question. A lower orange output means less orange juice. Demand for orange juice has not changed. “Rise. Qed.
One commenter raised a passive question about how much the price of orange juice would rise, but I can’t be relieved if it would rise.
AMW wrote:
Is this an open economy or a closed economy? Is it positive to import/export orange and orange juice? And how resilient is the international supply and demand for oranges and orange juice?
These are all relay questions to estimate the extent of the increase. But let’s say orange producers export to Tovoid’s domestic price control. So domestic prices will be even lower than they would otherwise, and orange juice prices will rise even further.
Henri Hein said it well:
I’m with John Murphy and trying to simplify it. The orange price cap will lower the supply of orange. If we push for demand for orange juice (at the price before the change) it will remain the same. Therefore, the price of orange juice must rise.
repair:
One way to think about the issue is to think about the car market in 1946 after the US government allowed domestic car manufacturers to produce cars again for the domestic market. Everyher car producers were hesitant to prohibit price increases or the remaining price controls from increasing prices. Which one had I forgotten.
Aisher Way, the new car prices did not clear the market. Therefore, sub-car buyers buy a car and “flip” it. That means you sell at a higher price than you paid immediately. Orange juice producers should think of oranges as “turning them upside down.”
