Worked Problem: The Tortilla Price Stabilization Pact

“Thousands in Mexico City protest rising food prices.” So read the headline in the New York Times on February 1, 2007. Specifically, the demonstrators were protesting a sharp rise in the price of tortillas, a staple food of Mexico’s poor, which had gone from $0.25 a pound to between $0.35 and $0.45 a pound in just a few months.

Why were tortilla prices soaring? It was a classic example of what happens to equilibrium price when supply falls. Tortillas are made from corn; much of Mexico’s corn is imported from the United States, with the price of corn in both countries basically set in the U.S. corn market. And U.S. corn prices were rising rapidly thanks to surging demand in a new market: the market for ethanol.

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The Mexican government’s response was the Tortilla Price Stabilization Pact, an agreement with Mexico’s major tortilla producers to set the price of tortillas at 8.50 Mexican pesos per kilogram (about $0.78 per kilogram). The Pact aimed to address public concerns about rapidly rising tortilla prices.

This is a hypothetical supply and demand schedule for tortillas in Mexico:

Quantity of tortillas (billions of kilos)
Price of tortillas (per kilo in USD) Quantity demanded Quantity supplied
$1.40 1.6 2.8
1.30 1.7 2.6
1.20 1.8 2.4
1.10 1.9 2.2
1.00 2 2
0.90 2.1 1.8
0.80 2.2 1.6
0.70 2.3 1.4
0.60 2.4 1.2

Use a demand and supply graph to find the market equilibrium price and quantity. Show how a price of $0.80 creates a shortage of the good.

Draw and label supply and demand curves. Find the equilibrium quantity demanded.

Review the section “The Demand Schedule and the Demand Curve” (along with Figure 3-1) on pages 71–72, the section “The Supply Schedule and the Supply Curve” on pages 80–81 (including Figure 3-6), and the section “Finding the Equilibrium Price and Quantity” (and Figure 3-11) on pages 87–88.

The equilibrium quantity demanded is at point E, the point at which quantity supplied equals quantity demanded. As shown both in the supply and demand schedule and in the figure above, this occurs at an equilibrium quantity of 2.0 billion kilos and an equilibrium price of $1.00.

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Calculate the shortage of tortillas that would occur at a price of $0.80.

Review the section “Why Does the Market Price Rise if It is Below the Equilibrium Price?” on page 90. An example of a price below its equilibrium level that creates a shortage is given in Figure 3-13.

As shown above, a price of $0.80 corresponds to point A on the supply curve. The quantity supplied at a price of $0.80 can be found by starting at point A and following the dotted line down to the horizontal axis and observing that the quantity supplied is 1.6 billion kilos. Similarly, a price of $0.80 corresponds to point B on the demand curve. The quantity demanded at a price of $0.80 can be found by starting at point B, following the dotted line down to the horizontal axis, and observing that the quantity demanded is 2.2 billion kilos. The difference between the quantity demanded and the quantity supplied is 2.2 − 1.6 = 0.6 billion kilos. This difference can also be found from the supply and demand schedule. As shown in the schedule, at a price of $0.80, the quantity supplied (1.6 billion kilos) is less than the quantity demanded (2.2 billion kilos) by 0.6 billion kilos.