CASE 1 What will happen to the price of milk?

As always, the movement in milk price in India is determined by the quantity of milk supply in the market and by the consumers willingness to buy milk. Short run seasonal factors and long run decisions on the number and quality of herd size influences the milk supply. At present the Indian economy being in recession, consumer incomes are low and therefore low demand and market prices of milk. Supply of milk in the market is fairly predictable. During summer less milk is available for marketing .while during winters greater quantity of milk is marketed. So the milk prices rise in the summers and fall in the winter years. The reason for such variation in supply is mainly biological in nature. Some studies on milk production in India have revealed that the seasonal variation in milk supply is also accompanied by significant economic milk cycle of a period of 15-26 years. The economic milk cycle is a result of over- reaction of the milk suppliers to both the upward and downward price signals. At present, the Indian milk market is experiencing low supplies, high seasonal price but is on the rising side of latest economic milk cycle. Demand for milk has been found to be influenced mainly by the retail prices of the milk, consumer tastes and the personal disposable income of the consumers. Low demand of the milk in the India is attributed mainly to the shift in consumers taste (both in the urban and rural sectors) and depressed consumers incomes due to recession during 1997-1983. Now the economic indicators are suggesting an economic recovery. It is, therefore, expected that the milk prices will rise, which should serve as signal for milk producers to augment their production capacity. It is expected that a 5% increase in consumers disposable income results in 2% increase for the demand for milk. In order to understand the effects of current recovery it is suggested to estimate and compare milk prices under two alternatives conditions: (1) economic recovery during the current period, (2) zero economic growth i.e., continued recession. After a statistical analysis of the data, it was found that the personal disposable income of the consumers is likely to increase at the most at 3% rate. While in case of the second alternative it was assumed that the consumer expenditure would remain at the same level as last year. Forecast of monthly supplies of milk was arrived at for both the alternatives. It was estimated that the milk prices have gradually increased due to economic recovery and are 4 to 6 percent higher than if recession had continued. It is expected that as recovery picks up, the milk prices would further improve and are likely to go up further by around 10% during the current month next year. It is therefore expected that the anticipated income recovery will strength the market for milk producers in the country. Questions: 1) What are the various determinants of demand for milk 2) How far the milk prices affected by (a) seasonal factors, (b) cyclical factors, and (c) other factors? 3) What is the measure of income elasticity of demand for retail price of milk?

CASE 2 Resolving Chinas Power Shortage Shanghai is Chinas financial and business hub. In late July 2004, with daytime temperatures reaching 37 degrees Celsius, the citys electricity consumption surged to a weekly record of 14.35 million kilowatt hours. The city authorities resorted to asking 2,100 businesses to operate at night, and a further 3,000 others to adjust operating hours. Even high-profile multinational companies were not spared. General Motors and Volkswagen were ordered to suspend production for more than a week each. Shanghai Volkswagen spokesman Lu Jun explained, It's a rule. We have to cut power for 10 days Weve cut power and so have had to stop production. It's all over Shanghai. The Shanghai episode mirrored a nationwide shortage of electric power. In Beijing, on July 22, 2004, the Municipal Power Supply Bureau imposed the capitals first brownout of the year, disrupting supply to suburban areas for 47 minutes in the afternoon. The Chinese government has certainly been working tirelessly to resolve the power crisis. Thermal coal is the principal fuel used to generate electric power in China. In July, Premier Wen Jiabao exhorted, Railway departments should do their utmost for the transport of coal for electricity generation.2 The Ministry of airways increased train speed and freight loads, and allocated 90% of freight capacity to transport key materials. In the first half of 2004, Chinese railways shipped 480 million tons of coal, up 12.2% over the same period last year. The Ministry of Communications has also pitched in. It diverted ships from overseas routes to domestic coal transport and approved emergency coal transportation on various roads and waterways. China is the worlds second-biggest coal exporter. In 2003, China exported 93 million tons of coal, including 80.8 million tons of thermal coal. To assure supplies to the electric power industry, the Chinese government has limited coal exports to 80 million tons in 2004. China Coal Import & Export Vice President Zhou Dongzhou predicted that exports of thermal coal would fall to 70 million tons. Since the 1960s, the Chinese government has regulated the supply of thermal coal to electric power plants. It requires coal mines to supply power plants with about one-quarter of coal purchases at a contract price. The government regulates the supply of coal to support its regulation of the electricity industry. In the late 1990s, the Chinese government dissolved the Ministry of Electric Power, and divided its functions between the State Electricity Regulatory Commission (SERC) and the State Power Corporation of China. The State Power Corporation owns five of the six transmission grids Northwest, North, Northeast, Central, and East) and about half of the national generating capacity. Regulation is necessary to ensure that the State Power Corporation does not abuse its monopoly power. The SERC regulates all aspects of the electricity industry, except pricing. With regard to electricity pricing, the SERCs role is to advise the National Development Reform Commission (NDRC). To ensure that electric power generation is economically viable, mines are required to sell coal cheaply to power plants. Typically, the government sets the price below the equilibrium market price. Many mines have ignored their contracts with power plants and sold coal on the higher market price to earn higher profits. Some power plants cut back production, so exacerbating the national power shortage. Some estimate that the nationwide power shortage will soon reach 30 million kilowatts, which is more than double Shanghais peak consumption. With China headed fo r a power crisis, the government is under pressure to increase electricity prices. In June 2004, following persistent rises in the cost of fuel, the NDRC increased electricity prices by an average of 2.2

fen per kilowatthour in the East, North, Central, and South grids. But, apparently, this increase has not been sufficient. The threat of a power crisis continues. Discussion Questions 1. Explain how the impact of a price increase on electricity consumption depends on the price elasticity of demand. 2. The price elasticity of the Indian demand for electricity has been estimated to be -0.65 among residential users and -0.45 among industrial users. If these elasticities apply to China as well, how will the impact of a price increase be spread between residential as compared with industrial users? 3. Many Chinese organizations ignore the market system. For instance, they borrow money from banks and refuse to repay, thus creating bad debts for lenders. Likewise, they might consume electricity without bothering to pay the power supplier. Do such organizations cause the demand for electricity to be more or less price elastic?

CASE 3 Case on Rent of Apartments Lets us take the case of a well-defined geographic area of a city. The area is composed exclusively of apartments and is populated by low-income residents. The people who live in the area tend to stay in that area because (1) they cannot afford to live in other areas of the city, (2) they prefer to live with people of their own ethnic group, or (3) there is discrimination against them in other areas of the city. Rents paid are a very high percent of peoples' incomes. (1) State whether the demand for apartments in this area be relatively inelastic or relatively elastic? Also state why. (2) What is the nature of the supply curve of apartments in this area and why (3) Show the equilibrium price and output. (4) Now assume the government creates a program. Under this program, the renter is required to pay 30% of income in rent. Any additional rent is paid by the government --- up to a limit. For example, a low-income person with an income of $1,000 a month would be required to pay $300 in rent (30%). If the rent is $500, the other $200 would be paid by the government. Analyze the results of this program. Show the changes on the graph and explain what will result. Who gains and who loses from this program? (5) Instead, now assume that the government decides to provide a subsidy to people who build apartments in this low-income area. A certain percent of their costs will be paid by the government. Analyze the results of this program. Show the results on the graph and explain what will result.

CASE 4 Case on Tobacco Policy in India India is the second largest tobacco leaf producing nation and the third largest tobacco consuming nation. On October 2, 2008, Indias national smoke-free law came into effect. Healthcare facilities, educational facilities and government facilities have been designated as smoke-free environments. However, the law allows for designated smoking rooms in hotels, bars, restaurants and airports. Enforcement and compliance levels vary by state and city. Tobacco advertising is banned in major media formats and there are restrictions on advertising at point of sale. However, size and advertising context restrictions at the point of sale are not enforced. Tobacco companies engage in surrogate advertising, e.g., by promoting fashion shows, award functions like bravery awards for women and so on. Health warnings have to be printed on packs of cigarettes. But WHO feels that the graphic images are weak and do not convey the harms of tobacco use. Health warnings have been found printed on the back of the pack instead of the front as required and are of smaller size than the required 40% of the front display area. All these policies are designed to affect the demand curve for tobacco products. We know that the Govt. can tax tobacco products to bring down consumption and that the incidence of taxation will depend on the relative price elasticitys of demand and supply. The tax base of tobacco in India is heavily dependent on about 14% of tobacco users, who smoke cigarettes. Non-cigarette tobacco products accounting for 85% of the tobacco consumption contribute only 15 % of the total tobacco taxes. In many countries, taxation of tobacco products has been used as an instrument to discourage smoking. In India although cigarettes are taxed heavily, there is almost no tax on bidis (a leaf rolled local mini cigarette) and chewing tobacco. In the face of the rising taxes on cigarettes, cigarette smokers have been able to switch to cheaper methods of tobacco consumption. Explain the various factors affecting the demand for tobacco? How will you apply the various concepts of demand and supply that you have learnt? What should be the desirable option a ban on cigarette smoking in public or imposition of tax on tobacco? How do these programs affect the cigarette consumption? What would be the combined effect of both the programs

CASE 5 Tax on Petrol Petrol is a non-renewable source and the government wants to reduce the use of it also the use of petrol leads to air pollution. Thus, the govt aims at reducing its use of petrol and thus impose a Rs. 0.50 tax for each gallon of petrol sold. 1. Should they impose this tax on producers or consumers? Explain carefully using a supply and demand diagram. 2. If the demand for petrol are more elastic, would this tax be more effective or less effective in reducing the quantity of gasoline consumed? Explain . 3. Are consumers of petrol helped or hurt by this tax? Why? 4. Are workers in the oil industry helped or hurt by this tax? Why?

CASE 6 Optimal output decision the case of a small fast food outlet The location is the busy town of pune, with the young working population growing exponentially. Snacks such as paav (Indian /Maharasthrian equivalent of the American burger), are in great demand and so is the supply. Every small tea or snack shop sells it. The going price is Rs.10. a new entrant decides to set up one such stall. She estimates that the total monthly cost, including normal profit will be = 1000 + 2Q + 0.01Q The first question that she seeks an answer to is how much should she produce so that she maximizes ones profit. She has been told that this is a lucrative business and once she gets her production figure, she can sit back and enjoy the profits. You are required to do the following: 1. 2. 3. 4. 5. Assess the market structure in terms of characteristics Arrive at the profit maximizing output Assess how lucrative the business is in terms of economic profit Calculate how long will these profits last Assess the incentives to stay on if the economic profits do not last.