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I am learning the basics of Supply/Demand, and I came across this question (it's not a part of my homework; I just want to know the answer/explanation because I'm doing some extra practice problems for a test).

Question: "Starch from the stalks of potato plants is used to make packing peanuts, a complement in production. A decrease in potato demand that lowers potato prices will cause which of the following in the packing-peanut market?"

My thoughts:

So, we know potato prices decrease, and potatoes are a complement in production. From what I've learned, a decrease in the price of a complement in production leads to a decrease in supply of the original good (ie decrease in potato prices leads to decrease in supply of packing peanuts).

Now, what I don't understand is how demand plays a factor. I know that when the price of a complementary good is decreased, demand for the original good increases. But what's different in this case is that potatoes are a complement in production, NOT consumption. From the examples given in the text, everytime they mention how changes in complement goods affect demand, they are referring to a complement in CONSUMPTION.

What I'm confused about is potatoes' relationship to packing peanuts. Potatoes are a complement in production, so I'm thinking it shouldn't have any affect on demand for packing peanuts, since consumers are not concerned with processes of production, right? (So my answer would be that a decrease in potato prices leads to a DECREASE in supply of packing peanuts and NO CHANGE in demand of packing peanuts).

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You are right that most discussions talk about complementarity in consumption, which is why this question is all the more interesting.

Demand falls for potatoes, which causes the price of potatoes to fall, which causes the supply of potatoes to fall. This means there is less starch available. This in turn means that we can make less packing-peanuts, hence supply of packing peanuts falls.

You are right that demand for packing peanuts does not change. The supply will nevertheless change however. This is because the supply of starch falls and the input factor of packaging peanuts is more expensive, so less is optimally produced. I.e. the supply curve of packaging peanuts changes, in this case shifts to the left so there is less equilibrium supply even though demand for packaging peanuts has not changed.

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  • $\begingroup$ My first answer was that supply decreases while demand increases. I thought demand increased because as price of a complement good decreases, demand for the original good increases. Again, however, that example typically assumes complementary in consumption (it doesn't make sense to me that the consumer interested in buying potatoes would at the same time purchase packing peanuts). So, just for the sake of a better comprehension, can you explain why you also believe demand will not increase (and in fact why you also think it does not change)? $\endgroup$ – EconGuest Oct 11 '15 at 18:28
  • $\begingroup$ As you said, your first answer is correct only if there is complementarity in consumption. Since there isn't (nor is there mention of substitutability ), there is absolutely no relation between demand for potatoes and packaging peanuts, so there is no change in demand for peanuts. Consumers dont value or demand peanuts more/less because they demand potatoes less. If that were the case we'd have complementarity or substitutability in consumption by definition, which we don't have. $\endgroup$ – BB King Oct 11 '15 at 19:29
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Here is the chain of logic:

Demand for P falls $\implies$ Price of P falls $\implies$ supply for P falls/harvest of P falls $\implies$ supply of starch falls.

The supply of starch falls because the decrease in the harvest of potatoes causes a decrease in the availability of the input needed to produce the starch.

Keep in mind that there is no pressure placed on the demand for starch. So,you will not shift the demand curve in your simply supply and demand graph used to represent the market for starch.

The only shock to the starch market comes from the decrease in supply of starch that results from the decreased harvest of potatoes.

And so to finish it all off:

If you hold demand for starch constant and decrease the supply of starch, the equilibrium price of starch rises.

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