economics

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Demand and supply in the Sugar cane market

Q1. (a) The cost of parking might include real estate costs, electricity costs, watchmen costs etc. These costs wouldn’t decrease by fall in price of parking permit. It’s just a change in policy of campus to make parking available for more people. With this reduction, the institute might still make more profit if the number of parking cars increased is offset by the decrease in parking permit fee. This would naturally depend on the price elasticity of the demand for parking; but the bottom-line is that change in price of parking is more of a policy decision with no effect on the cost of parking.

(b) Drought in Australia has reduced the wheat output and hence the wheat being exported to USA has been reduced. This shortage of wheat due to reduction in import has shifted the overall wheat supply curve of US towards left on the demand-supply graph and hence leads to increase in price. Thus the price increase incentivizes the US farmers to produce more to bridge the demand-supply gap. Overall, this would benefit the farmers of US and Australian farmers might lose some of their share of income.

Q2. (a) (i) Price on Y-Axis and Quantity (demand) on X-axis.

The increase in demand of coffee has shifted the Demand curve from D1 to D2. So even at same demand (around 9) the price has increased from 19 to 25 (in short term).

In the long term the price and quantity would shift to a new equilibrium point i.e. the intersection point of the curve S & D2. Although we might also see an increase in the ‘supply’ due to higher margin in coffee but that’s a different game altogether.

(ii) Price on Y-Axis and Quantity (demand) on X-axis.

The shortage of bananas is a direct impact of the devastation caused to the agriculture by the northern Queensland floods. This leads to a leftward shift of the Banana Supply curve (S1 to S2). This resulted in increase in Banana prices.

Q2 (b) The price elasticity would not be same for a place like Perth as compared to Australian outback. This is because, there are various factors involved which affect the price; the significant ones here being as follows -

Luxury products share a high elasticity of demand

Also goods which form a considerable part of a consumers budget have higher elasticity as compared to other goods

Since, the demographics of the two places are different hence; there will be difference in the price elasticity of demand for calls made from mobile phones in two regions.

Q3. (a) (i) Calculating Peter’s marginal benefit from ice-cream as shown below –

Litres of ice-cream

Willingness to pay

Marginal benefit

0

$ 0

1

$ 10

$ 10

2

$ 17

$ 7

3

$ 22

$ 5

4

$ 25

$ 3

5

$ 27

$ 2

6

$ 28

$ 1

(ii)

The demand table for Peter is as follows:

Price

Demand

4.67

6

5.40

5

6.25

4

7.33

3

8.50

2

10.00

1

Price on Y-axis (dollars); Quantity on X-axis (litres).

(iii)

Now at $5 per litre of ice-cream, Peter would buy approx. 5 litres of ice-cream.

Q3. (b) In a market, there is a demand and a supply curve defined for every good/service. The supply curve defines the price a producer is willing to accept for a given amount of good/service to be provided. The demand curve shows the willingness of the consumer to buy a good/service at a given price. The intersection between the Demand and Supply curve is known as the equlibrium point and it defines the equilibrium quantity and equilibrium price.

Producer Surplus is essentially the difference between the equilibrium price defined by the market and the lowest price the producer is willing to accept for its goods. The greater the difference between the two prices, larger is the producer surplus.

surplus2

As can be seen from above, the area above the supply curve i.e. the purple line, below the equilibrium price and left to the intersection point is known as the Producer Surplus.

Example: Suppose the Demand and Supply curves are as follows:

D = 32 – 4P

S = 3P – 5

The graph for the same would be as shown below –

Surplus_correct

Blue shaded part represents the consumer surplus; whereas the grey shaded part represents the producer surplus for the given set of equations.

Now, the equilibrium price is at D = S.

i.e. 32 – 4P = 3P – 5

P ~ $ 5.29 & Q ~ 10

Now, the lowest value the producer is willing to agree to be $ 1.67; however the producer is receiving $ 5.29. The difference in these amounts creates the Producer Surplus.

Q4. (a) Deadweight Loss – It’s the inefficiency caused by some action, such as tax, price controls etc, which leads to market distortion and eventually a net loss in social welfare. The loss is actually due to the transactions which could have taken place but were prevented by the market distortion.

Taking the example from previous question and imposing a tax on goods, would lead to a loss of consumer surplus and producer surplus. This loss would actually consist of Government Revenue from the tax and the deadweight loss.

deadweight loss

In the graph above, the areas shaded in the following colors are –

Blue  Consumer Surplus

Yellow  Government Revenue from tax

Purple  Deadweight loss

Red  Producer Surplus

Now as evident from the graph, the taxes has the following effect on the market – the effective price received by suppliers decreases and the price being paid by customers increases. This discourages the occurrence of transaction of the good/service in the market. Hence, in greater interest of society the government is more likely to impose tax on alcohol as compared to luxury cars.

Q4 (b) Now, here the Price of a product is equal to the Average Variable Cost. The price is decided at this value as fixed cost is actually a sunk cost and hence it is not taken up in the calculation of product pricing. So at equilibrium, the firms are essentially selling at the average variable cost and just able to cover up their costs and having zero profits.

Since, the fixed costs are not taken in calculation and all the firms are almost on zero margin profits, hence the loss they are bearing is actually the fixed cost itself.

profit

In short run, it’s possible that some firms may make some economic profit as shown in figure above. But in the long run, this profit is not sustainable. The firms eventually would be making only some normal profit but zero economic profit, as evident in graph where the demand curve is tangential to the average cost curve.

300px-Economics_Perfect_competition

Case Study

Introduction

Sugar Industry is one of the closest paragons of perfect competition in the real world. With innumerable producers of sugars across the markets and with almost negligible scope of differentiation between the products, the sugar industry is essentially a price-taker.

Concept: Perfect Competition

As we know, in perfect competition the firms make no profit as they barely cover their variable costs. In the long run the firms end up making losses (economic loss) which is equal to the Fixed Costs of the firm. The graph below also exhibits the same concept. We can see that the demand of sugar is determined from the first graph (Demand-Supply graph for the sugar industry) by equating Sindustry to Dindustry. The demand calculated from here is then carried over to the next graph (Demand-Supply graph for an individual firm) where Demand is equal to the Marginal Revenue or Average Revenue or Price of sugar. The demand, as we see from second graph is perfectly elastic and any increase in price by the firm would result in loss of market share for that firm. Now, the equilibrium quantity for the firm would be decided on the basis of MR=MC approach, as this would lead to profit maximization. Now at the equilibrium quantity calculated the Price for the commodity is less than its Average Total Cost. This is where we see that effectively the firm is making economic losses. Another example for such industry can be the low cost airlines industry in India.

perfect competition

Figure - http://welkerswikinomics.com/

One thing to be observed here is that the situation is not always like this, otherwise there would be no incentive for a player to enter the market. In the short run, some firms do make normal profits and some even supernormal profits; but it all depends on the position of the short-term cost curve. As show in the below graph, this firm has short run cost curve such that the market price prevalent is more than its cost. However, in the long run all these factors normalize and all firms are at the same pedestal.

profit

Canegrowers: As an association

In a perfect competition, all the producers are always low on margins and facing a stiff competition. So, it doesn’t makes business sense for an individual organization to expend money on increasing sales; as there is no guarantee of achieving any material revenue growth given the large number of suppliers and buyers. Moreover the information being free and symmetrical would never let the supplier charge any amount higher than the market price. Hence, in such a scenario it’s in the best interests of all the suppliers to pool their knowledge & resources and work out on the process of maximizing their returns by reducing their costs. This leads to establishing of industry associations, which is designed to work in the best interests of the industry. Canrgrowers is one such association of sugarcane suppliers which works for the sugar industry and aims at sustaining the profitability of the producers and sustaining the sugar industry as a whole.

Canegrowers: As a task force

The Canegrowers as an association is responsible for the development of techniques which help the sugar producers in getting the maximum return out of their crops. These techniques are a part of the ‘quality assurance’ activities they undertake on the behalf of producers as a whole. As described in the video, the techniques used are polar technology and new-infrared Spectrophotragpy. These techniques are used extensively to measure the sugar content in the sugarcane juice (using various pre-calibrated parameters) and enhance the output of the producers. Also any impurities in the juice are washed away ensuring that the sugar itself is not wasted in the process.

This way not only would they better the quality of sugar they produce, they would also increase the amount of sugar produced. By developing new and improved ways of removing impurities, Canegrowers is helping the industry in lowering their variable costs and increasing their margins.

Sugar Industry Elasticity

The elasticity of a product depends on several factors. Let’s first enlist the major factors that contribute to the elasticity of the product –

Availability of Substitutes

Amount of Income allocated to spend on the commodity

Necessity of the product

Time Span

Now, we will analyze these factors with respect to sugar industry and try to gauge the elasticity of sugar industry.

Availability of Substitutes: This alone is one of the major factors of elasticity and it pretty much defines the fate of a commodity. Taking sugar as a product we find that sugar has high elasticity as there are substitutes available for sugar such as jaggery. So if the price of sugar goes up (ceteris paribus) then people would tend to shift towards jaggery to satisfy their need for sweet inducing commodity. Also, there are some artificial sweeteners available in market which can to an extent act as a sugar substitute. Whereas, if the price of sugarcane itself goes up then there would probably be little change in the consumption of sugar or jaggery. This is because there are no real substitutes for sugarcane and people might not be ready to give up their sweet needs. So, we see that a product within an industry might be elastic but the industry as a whole itself is not elastic.

Amount of Income allocated – Sugar being a daily consumption product would have a monthly budget allocated to it. With

Necessity of product – Although this would depend on the demographics of the region but talking in general the necessity of sweet can’t be done away with and hence there would always be demand for this product.

Time Span – Longer is the price change for a product, higher the elasticity would be for it. For example for once you may buy sugar at high price but if you see a permanent change in the price for sugar then you might eventually shift to jaggery.

Hence, the concept of elasticity of demand is a very useful concept in understanding the demand for sugar in the short run as well as long run.

Sugar Industry – Factors affecting Supply & Demand

Sugarcane growing is a long process (taking 1.5 to 2 years from planting to harvesting); so depending on the weather and also dependent on many natural hazards such as floods, tornados etc. and the impacts of pests and diseases. This type of abrupt changes can seriously alter the supply of sugar and hence the price of sugar in market (especially international market) fluctuates very frequently.

Talking about international market, there are two major factors that influence the price –

International trade is a very small proportion of total production and consumption of world

Protection policies adopted by some European nations, US, Japan etc.

To reduce the uncertainty of prices, sugar futures and options are readily traded in derivatives market and major chunk of the commodity is sold through these contracts only. This reduces variability in the ‘spot’ prices of the sugar in market. Also, individual producers are shielded from this price fluctuation by entering into long-term contracts to sell a significant proportion of their output. (“The Australian Sugar Industry”, Industry Commission, 1992)

The factor to be considered from supplier side while deciding for the equilibrium price and quantity is mainly the cost of production of sugar. Apart from that, the technology developed to increase the output and other logistics costs, form the major chunk. After that it depends on the interactions between suppliers and buyers to decide upon the equilibrium price and quantity. Since, the producers are price-takers hence only some firms can’t influence the price of the sugar in market. Also since the demand at firm level is perfectly elastic hence any increase in price by one supplier would lead to zero quantity sold for that buyer. Talking at an industry level, the demand for sugar is almost inelastic and the once the equilibrium price is reached after that no individual firm can demand more than that price (as shown in graph above).

Australian Sugar Industry

In Australia, the major regions where sugar is cultivated are New South Wales, Queensland and Western Australia. It’s cultivated majorly in the high-rainfall coastal areas or river valleys of these regions. This industry is one of the most important rural industries of Australia, with the total size of $ 1.5 - $ 2.5 billion. (www.cranegrowers.com)

The statistics for the industry are –

Cane production = 32 - 35 metric ton

Raw Sugar = 4.5 – 5 metric ton

Number of Cane Farm Businesses = 4000

Number of Sugar Mills = 25

Value of Production = $ 1.5 billion to $ 2.5 billion

Australia is one of the largest exporters of raw sugar with 80% of the raw sugar produced being exported to Asia & US.

The sugar market of Australia is like any other global sugar market structure i.e. it’s close to perfect competition. Due to poor production techniques and profitability the industry saw a decline in mid 2000’s.

Industry Structure

The industry has wide network of various types of organizations. This network is essentially meant to support the industry in areas like R&D, marketing, infrastructure development etc. These organizations can be divided into peak bodies, government agencies, research and development institutions and grain marketing organizations (www.anra.gov.au). The organizations are –

Peak Bodies –

Australian Cane Farmers Federation

Cane Growers

NSW Cane Growers Association

Ord River Canegrowers Association

Cane Harvestors

Millers

Rural Industries Research and Development Corporation

Government bodies –

Commonwealth Scientific and Industrial Research Organisation

Department of Agriculture, Fisheries and Forestry

Australian Quarantine and Inspection Service

Australian Bureau of Agricultural and Resource Economics

Bureau of Rural Sciences

Research and Development Institutes –

BSES

Sugar Research and Development Corporation (SRDC)

Cooperative Research Centre for Sustainable Sugar Production

Environmental Challenges faced by the Industry

The major environmental challenges faced by Australian Sugar Industry are –

Irrigation and Drainage

Soil Management

Dangerous goods and chemicals (licensing for fuel storage in excess of 10000 L)

Fertilizer Management

Herbicide Management

Waste Management

Ecology and Conversation

Current Situation of the Industry

The Australian sugar industry is now under the recovery phase after it saw a decline in profits and production for the last 4-5 years. A turnaround in the sugarcane plantation and sugar production is expected in 2010/11. This is expected majorly because of the rising sugar prices worldwide and improved seasonal conditions for sugarcane plantation. ABARE reported sugarcane prices for 2009/10 to be around AUD 509/MT, which was around 52% higher than previous year. It is expected to go even higher in 2010/11. Below are a couple of graphs which depict the industry scenario as of now.

Source – ABARE Data

The figure below shows the decline of area under plantation of sugarcane over the years. The 2010/11 figure is the expected area to be covered, and if it happens then this would be the single largest percentage increase in the sugarcane plantation area in a decade.

Source – ABARE Data


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