Friday, May 18, 2007

Unintended Consequences

There's a great piece in The Wall Street Journal on today's (5/18/07) Opinion Page (link no longer operative). It talks about some of the unintended consequences (read trade-offs and opportunity costs) of the big push to use corn for ethanol to fuel our energy hunger.

The problem is that the increased demand for corn to be processed into ethanol has pushed corn prices up significantly. The ripples have been felt at various points within our economy. The cost of corn used for animal feed has shown up in meat prices; the cost of corn for grain-based products has shown up in cereal prices; and cost of corn for corn syrup has impacted even soft-drinks. And the article doesn't even mention the impact on corn prices in other countries. (Mexico has implemented price controls on certain foodstuffs based on corn.)

The article points out that attempts to circumvent one aspect of the market by fixing the price of a commodity, the impact is felt in other areas. This is a great example to share with your students.

Your reactions and comments are welcome.

**Update**This may not be an update to many of you, but I've been out of the office and away from regular news sources since last week. There was a story in Monday's (5/21/07) issue of The Wall Street Journal that takes this story to the next step. An application of the substitution effect in economics. The story was excerpted in this story in The Denver Post. And you get the idea. When corn becomes too expensive for farmers to use as feed, they find substitutes. It's interesting to see what the substitutes are. (Also interesting to note in the Journal's longer story, farmers are selling the corn they raise rather than feed it to the animals as they may have originally planned.)

Posted by TSchilling at May 18, 2007 1:55 PM

What price has been fixed? Both the price of gas and of corn are free market prices. Or have I missed someone imposing price controls? The impacts you are pointing out all seem to be the product of the natural workings of free markets.

Posted by: spencer at May 18, 2007 2:59 PM

You are correct. The word "fixed" is too strong, and implies something that is not the case. However, it should be apparent that legislation that subsidizes the production of ethanol has the effect of moving the demand curve for corn to the right, thus raising the price.

One can certainly argue that market forces would have done this anyway (substitution effect), but I suspect it would not have happened quite as fast. Certainly, many of the land use repercussions were not adequately thought out, and I doubt very many saw the impact on food prices as this significant, as food processors compete with fuel processors for the same crop. I know I didn't see any discussion or debate about the possible impact on the consumer's grocery bill.

Posted by: Tim at May 22, 2007 9:21 AM

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