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Supply and Demand:Will Fracking Enrich

India’s Guar Farmers?July 30, 2012

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What is Guar?

Guar is a small bean that is the source of guar gum, a substance that forms a gel when mixed with water

Guar gum is widely used in foods ranging from baked goods to ice cream, which need to retain moisture for maximum shelf life

More than 80 percent of the world’s guar is produced in India

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Fracking Sends Guar Prices Soaring

Guar is also used in hydraulic fracturing (fracking), a method of producing oil and gas

Increased use of fracking sent guar prices soaring in early 2012

In the first half of the year guar prices more than doubled as big producers built up stockpiles to guard against supply interruptions

These events have people asking, will fracking bring riches to India’s guar farmers?

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Hydraulic Fracturing Operation, Texas

Question: How Does the New Use Affect the Price?

How does fracking, the new use for guar, affect the price?

Does the demand curve shift? If so, show the new demand curve as D2

Does the supply curve shift? If so, show the new supply curve as S2

Show the new equilibrium price as P1

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Answer: How the New Use Affects Price

The new use of guar will shift the demand curve to the right. The new demand curve is shown here as D2

Nothing has affected the “other things being equal” conditions behind the supply curve, so the supply curve does not shift

The market moves along the supply curve until a new equilibrium price is reached at the level P1

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Short-Run Supply Effects: Growing Conditions

Guar supply, like that of any farm product, is subject to changes in growing conditions

In 2012, monsoon rains were late in the parts of India that grow guar, causing possible crop loss

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Monsoon Season in IndiaPhoto source: deeptrivia

http://commons.wikimedia.org/wiki/File:Ladakh_india_monsoon_clouds.jpg

Question: How Do Late Rains Affect the Price?

Other things being equal, how do poor growing conditions (late rains)affect the price?

Does the demand curve shift? If so, show the new demand curve as D2

Does the supply curve shift? If so, show the new supply curve as S2

Show the new equilibrium price as P2

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Answer: How Late Rains Affect the Price

Poor growing conditions will cause the supply curve to shift to the left, for example, from S0 to S2 as shown here.

Other things being equal, growing conditions will not affect the demand curve

The market moves long the demand curve until a new equilibrium price is reached at the level P2

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Short-Run vs. Long-Run Supply

In the short run, supply of guar is inelastic because opportunities to expand production is limited

In the long run suppy is more elastic because guar can be substituted for other crops, like cotton

Also, guar crops could be established outside India in countries including Australia, Argentina, and the United States

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Cotton Ready for HarvestPhoto by Kimberley Vardeman

http://commons.wikimedia.org/wiki/File:Cotton_field_kv43.jpg

Question: Short-Run vs. Long-Run Market Adjustment

How do you expect long-run adjustment of the guar market to differ from short-run adjustment when there is a permanent shift in demand? (Assume normal growing conditions)

Draw a diagram that shows both short-run and long-run supply curves

Show a rightward shift in the demand curve

Show how the market first moves to a short-run equilibrium E1 and then to long-run equilibrium E2

What happens to the price over time?

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Cotton Ready for HarvestPhoto by Kimberley Vardeman

http://commons.wikimedia.org/wiki/File:Cotton_field_kv43.jpg

Answer: Short-Run vs. Long-Run Market Adjustment

In the short run, the shift in demand causes the market to move along the short-run supply curve SSR from E0 to E1

In the long-run, expansion of the crop to new growing areas allow the market to move to equilibrium E2 on the more elastic long-run supply curve SLR

Over time, then, the shift in demand causes the price first to rise sharply to P1, and then to fall back partway to an intermediate price like P2

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

The Bottom Line

The bottom line? In the short-run, new demand from fracking will bring prosperity to India’s guar farmers

Over time, high prices will encourage spread of the crop to new areas

The price will moderate. Farmers in favorable growing areas will still earn good profits, but not as high as the short-run windfall profits they enjoyed in 2012

P120730 published Aug 1, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/