Domestic Price = International Price

Note: To the LEFT of each ARROW the World Price is Greater than the Domestic US Price.There have been occasions where they were equal. Just go with me on this!

PriceOf

Butter

Market for Butter

S*

D*

P domestic

Qe

Here is the Market for Butter in the US.

It is in Equilibrium at “Pe” and “Qe”.

Looking at the graph provided you will see that the US price and the World price are not the same (for the most part).

When the price divergence is significant enough and it persists for a long enough period of time it can have a disrupting affect in the market.

Lets see what that can look like.

“A”

Quantity of Butter

PriceOf

Butter

Market for Butter

S*

D*

P domestic

Qe

If you look at the graph for the price of butter in the first slide you will notice the world price for butter is HIGHER than the US price for butter.

If you are a holder or producer of a stock of Butter in the US, who (or where) do you want to sell it?

You will first sell to the people in the US who are willing and able to pay the higher world price (Point “B”). Notice that is not as many as before at Point “A”.

Then you will increase the quantity supplied (move ALONG the Supply curve from Point “A” to “C”) at the higher price to Point “C” for the foreign market

P World

“A”

“B” “C”

Quantity of Butter

PriceOf

Butter

Market for Butter

S*

D*

P domestic

Qe

At the higher world price the quantity suppliedwill be higher than the domestic quantity demanded. If the butter stocks did not exist then there would be a shortage.

The difference is made up in the draw down of the US stock of US butter. The difference between Point “C” an Point “B” is made up in EXPORTS of US butter stock.

This can go on…until it can’t! The market is a cruel master….

P World

“A”

“B”

Q supplied

“C”

Quantity of Butter

Q demanded

EXPORTS“C” MINUS “B”

PriceOf

Butter

Market for Butter

S*

D*

P domestic

Qe

As we move through time and markets adjust and change with consumer tastes, we can see from the graph that the US Price of Butter increases and the World price DECREASES.

So much so, they start to move in opposite directions….

“A”

Quantity of Butter

PriceOf

Butter

Market for Butter

S*

D*

P domestic

Qe

Now the World price is BELOW the US price.

One caveat: The “real world” situation is not quite to this point yet. Butter prices in the US are still elevated BUT trade figures are showing that lower price foreign butter is starting to make its way into the US market place.

You can see the opposite is likely to happen in the US. Demanders will increases their quantity demanded for lower price foreign butter (move ALONG the Demand curve from Point “A” to “C”).

As the price decreases, domestic holders (and producers) of butter will have less incentive to bring butter to market at the lower prices (Point “B”)….

P World

“A”

“B” “C”

Quantity of Butter

Q supplied Q demanded

PriceOf

Butter

Market for Butter

S*

D*

P domestic

Qe

We will now have a situation where the difference between Quantity Demanded for Domestic and Foreign butter (Point “C”) is greater than the Domestic US Quantity Supplied (Point “B”).

Instead of producing a “shortage” the US will IMPORT the difference between Point “C” and “B”.

P World

“A”

“B” “C”

Quantity of Butter

IMPORTS“C” minus “B”

Q supplied Q demanded