Both ethanol and sugar are made from sugar cane and ethanol can be used as a substitute for oil. As the price of oil increases, Brazilians shift sugar cane from sugar production to ethanol production, thereby:
A. increasing the price of both ethanol and sugar.
B. decreasing the price of both ethanol and sugar.
C. increasing the price of ethanol.
D. increasing the price of sugar.
The correct answer and explanation is:
The correct answer is C. increasing the price of ethanol.
When the price of oil increases, ethanol becomes a more attractive substitute for oil, particularly in countries like Brazil where ethanol is produced from sugar cane. The shift from sugar production to ethanol production leads to a reduction in the supply of sugar, because more land and resources are devoted to ethanol production instead. This change in resource allocation affects the supply dynamics of both sugar and ethanol.
Ethanol, being a substitute for oil, will experience a rise in demand as oil becomes more expensive. With a shift in sugar cane resources towards ethanol production, the supply of ethanol increases, but the demand for ethanol increases even more due to its role as an alternative to oil. This combination of higher demand and increased production can lead to a higher price for ethanol.
On the other hand, because the supply of sugar decreases (as less sugar cane is available for sugar production), the price of sugar will likely increase due to a supply shortage. However, the direct effect on ethanol is more pronounced because its price is influenced by the demand for oil substitutes.
Therefore, the price of ethanol is the primary one to increase in this situation, while the price of sugar may also increase but to a lesser degree. The increase in the price of oil plays a crucial role in this shift by making ethanol more valuable as an oil substitute.