Case study

CORN is now struggling to keep up with demand.  With corn supplies the tightest they have been since the mid-1990s, prices have risen substantially and are holding at double normal levels.  As the US rolled out its renewable fuels program, production for the biofuel [ethanol] increased 10-fold during the past decade to more than 50 billion litres.  About 40 per cent of the US corn crop is now used for ethanol production.  Another 40 per cent goes directly into animal feed, while only a small proportion is used for food such as corn chips and tortillas.  The rest is converted into a range of other products such corn syrup and cooking oils.  While ethanol production has become the largest use of the corn crop, it has also developed a high protein byproduct -- dried distillers grains with solubles -- now highly prized around the world as an animal feed.  Demand by the animal feed and ethanol markets -- not only in the US, but around the world -- are likely to drive the global corn market in the foreseeable future.  Whether farmers can keep producing enough corn remains to be seen.

Questions:

Assume for all questions that corn production is a perfectly competitive industry, and that all corn producers have the same costs.

1. Draw a diagram, and explain the long run competitive equilibrium for the corn market and for a typical corn-producing firm in that market, prior to the increased demand for corn due to increased animal feed and ethanol production purposes.

2. The article mentions that the increase in demand for biofuels (ethanol produced from organic matter for the use of fuelling motors, such as motor vehicles) and for animal feed has increased the demand for corn, and increased the price of corn. Draw a diagram, and explain the effect of an increase in demand on the corn production market in the short run.

3. Assuming that this is a constant cost industry (that is, the average costs for the firm do not change as the industry expands production) show the new long run equilibrium for the corn production market, assuming the demand for corn stabilizes at the new, higher level of demand.             

4. The article states that corn prices "have risen substantially and are holding at double normal levels." Assuming that the corn production market is in a long run equilibrium, and the prices referred to are 'real' prices (ie inflation in prices has been accounted for), do you think corn production is a constant cost industry? Briefly explain. Please keep your explanation only to the issues we have discussed in this topic to date.