The prices of some bakery items are increasing. Customers do not understand. One bakery has actually put up a sign apologizing to customers. But it is not the fault of the bakery. The culprit is the rising price of butter, which has gone from $1.72 a pound at the beginning of the year to $3.19 by early October. In fact, prices in grocery stores have been as high as $4.89 for name brands and $3.99 for off-brands. This is significant: each batch of peanut butter cookies calls for one stick of butter that costs more than a dollar.

Butter prices are up in part because of declining milk production. The number of dairy farms has decreased from 100,000 to 92,000 over the past year. Moreover, a wet winter and a dry summer in key milk-producing states such as California and Texas reduced milk output.

Over the long term, consumers have increased their consumption of butter from 3.7 pounds per capita in 1991 to 4.2 pounds in 1997. Also, as the holiday season approaches, more people are baking, wanting more butter.

1.	Draw a diagram of the market for milk, with axes representing the price and quantity of butter. Show the demand and supply curves and the equilibrium price and quantity.
	a) The number of dairy farms is decreasing and there has been unseasonable weather. Which curve is affected by these developments? How does it shift? Illustrate on your diagram.
	b) What is happening to the price and quantity of milk as a result?
2.	Now draw a supply and demand diagram of the market for butter. Mark the initial equilibrium price and quantity.
	a) Which curve is affected by the higher price of milk? Why?
	b) Which curve is influenced by the long-term and seasonal trend in consumers' taste for butter? Why?
	c) On your diagram, illustrate the effects of the changes in (a) and (b). Carefully show how the equilibrium price and quantity change.
3.	Finally, draw a diagram of the market for bakery goods.
	a) Show the effect of the higher price of butter on the equilibrium price and quantity.
	b) In terms of economics, should bakery store owners apologize for the higher prices of baked goods? Why?