Explaining the Hike in the Price of Butter Using Demand, Supply and Elasticity Concepts

Answer

A “hike” — a sharp rise — in the price of butter requires both that demand rises and/or supply falls, and that the relevant elasticities are low enough to translate those shifts into a large price change. The preamble supplies demand-raising and supply-cutting events together with two elasticity clues — strong Asian growth (income) and very low butter stocks (supply responsiveness) — so the events reinforce one another to produce the price hike.

Demand factor — taste and preference. Health authorities’ recommendation to avoid the trans-fat in margarine shifts consumers’ tastes towards butter, raising the willingness and ability to consume it and shifting the demand curve rightward. (This is a change in taste, not a cross-price effect: CED applies only when the price of a related good changes, which is not the case here.)

Demand factor — rising income (YED). Strong growth in Asia raises incomes, and since butter is a normal — plausibly luxury — good there, its income elasticity is $YED > 1$, so demand rises more than proportionately with income, shifting demand rightward by a larger extent and amplifying the upward pressure on price.

Supply factor — higher cost of production. A decline in global milk production raises the price of milk; since milk is a factor input to butter, the cost of production of butter rises and its supply curve shifts leftward.

Supply factor — competitive supply with cheese. Milk can be turned into either butter or cheese, so the two are in competitive supply. As dairy regions prioritise higher-returning cheese, the higher relative price of cheese draws resources away from butter, further reducing butter supply and shifting it leftward.

Elasticities amplifying the price change. Two elasticities make the price change a hike rather than a mild rise. The very low butter stock means producers cannot respond quickly, so the price elasticity of supply is low ($PES < 1$): against an inelastic supply, the demand increase raises price sharply. And in the Christmas baking season, with butter a near-necessity for festive goods and weaker substitutes available, the price elasticity of demand is low ($|PED| < 1$): against an inelastic demand, the supply fall raises price sharply.

Both shifts push price in the same direction while quantity moves ambiguously, and the low $PES$ and low $PED$ ensure the combined effect is a sharp rise — the record-high price of butter.