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ECO100 Introductory Economics For Price of the Industry

Questions:

a.Draw a graph and use it to explain and illustrate the impact of trade on consumers, producers and the Australian economy.
b. Now Canada imposes an import quota on Australian beef. Draw a graph and
c. explain how this quota would influence the following factors in Canada:
(i) price of beef; (ii) consumer surplus (CS) and producer surplus (PS); (iii) beef  importers’ gain; (iv) efficiency of the beef market.
 
c. The volume of import quota on Australian beef is less than Australia’s total export volume of beef to Canada. Explain how this import quota would influence the following factors in Australia: (i) quantity of beef exported to Canada; (ii) price of beef; (iii), consumer surplus (CS) and producer surplus.
 
d. Suppose that the government decides to subsidise exports of beef by paying a certain amount for each tonne sold overseas. Explain how the export subsidy would affect the following factors in Australia: (i) domestic price of beef; (ii) the quantity of beef produced; (iii) the quantity of beef consumed, and the quantity of beef exported; (iv) consumer surplus, producer surplus, and
government revenue. 

Answer:

Trade agreements are trade ties between countries or regions that boost trade between them by removing trade barriers such as tariffs and quota. Trade is an important economic activity that contributes immensely to economic growth of countries (Bos, 2014). The free trade agreement between Australia and Canada has huge impact on consumers, producers, and their economies. The diagram above illustrates trade between Australia and Canada. At point Pe, the domestic production of beef in Australia is equivalent to domestic production. Excess supply is obtained as Qs-Qd and is sold at prices over price Pe. Trade enables producers to dispose surplus products to domestic and international markets. Through the free trade agreement between Australia and Canada, Australia benefits from acquiring more market for its beef products. Australia can increase production of beef beyond its demand so as to meet international markets. Trade also creates an opportunity where countries acquire goods from other countries in form of imports (Dabla-Norris & Duval, 2016).

In Canada, the prevailing beef market price is lower than the market equilibrium price of the domestic market. The amount of beef products demanded by customers is greater than amount supplied when retailing prices are lower than Pi. Through importing beef, Canada benefits by acquiring high quality meet from Australia.  Canadians are also able to obtain a variety of beef products to choose from. The expansion of the economy occurs in Australia when the beef industry flourishes as a result of the free trade agr


eement (Egan & Gumaraes, 2017).Beef farmers and beef processing industries would grow their businesses and thus lead to economic growth in Australia.

  • Canada imposed an import quota on Australian beef. Present a graph and explain how the quota would affect; (i) Price of beef (ii) consumer surplus and producer surplus (iii) beef importers gain (iv) efficiency of the beef market.

When Canada impose quotas on Australian beef, it restrict the amount of beef imported from Australia. The imposition is conducted by limiting the amount of beef import licenses or fixing a limit on imports. The price of beef in Canada would increase due to a decline in quantity supplied. A decline in quantity supplied implies that consumers have access to little amounts of product and thus might have to pay more for the beef.  Local producers of beef would sell more of the product at higher prices. Consumer surplus is that difference in the amount that customers are willing to pay and the price that they actually pay (Ehrenberg & Smith, 2016). The import quota imposed by Canada causes a rise in consumer surplus through area A to D in the graph.

  • The volume of import quotas on Australian beef is less than Australia’s total export volume of beef to Canada. Explain how this import quotas would influence the following factors in Australia. (i) Quantity of beef exported to Canada; (ii) price of beef (iii) consumer surplus and producer surplus.

When the volume of import quotas of Australian beef exported to Canada is less Australia’s total beef export to Canada, the quantity of beef exported to Canada would decline. The import quota would only affect size of imports when the import quotas are lower than the current exports (Gopinath, et al., 2014).

The price of beef would be significantly affected when import quotas are lower than Australia’s beef exports to Canada. The quantity of beef supplied by Australia to Canada would be affected since significant changes in supply occurred, the price would of beef products in Canada would also increase.

Consumer surplus is the difference between the sum of Australian beef that consumers are ready and able to purchase and sum of all that they purchase (Bernanke, et al., 2015). Quotas lower than quantity imported, reducing consumer surplus since consumers shall pay more for Australian beef products (Hamilton, 2017).

Producer surplus defines the difference between the sum of money that a producer is ready and able to pay and the actual money he receives from selling a product (Hong & Li, 2017). When Quotas are set below quantity imported from Australia, producer surplus increases.

“More than one billion of cups of coffee are consumed in Australia’s cafes, restaurants and other outlets each year, an increase of 65 per cent over 10 years. People are drinking less ‘instant coffee’ as espresso becomes more popular and new specialty coffee shops have been popping up all over Australia to satisfy demand for daily caffeine fix. Not only are people drinking more coffee, they are becoming more coffee-savvy and want premium brew even if it costs more.” 

  • How would you classify the espresso coffee market; are firms price takers or price makers?

The espresso coffee market in Australia is a monopolistic competition market structure since small firms compete against each other. The products are similar although slight differentiation might occur from the difference in customer service. The market can also be classified as imperfect because customers might not have full information concerning prices in the market.  Firms are price makers since they can charge competitive prices up to a reasonable range while customers are willing to consume premium brew even at a higher charge.

(b)With the aid of an appropriate economic model, explain why there has been such an explosion in the number of coffee chains in Australia over the past ten years.

There has been a significant rise in demand of coffee in Australia over the last 10 years. The news clip highlights that consumption has increased by around 65% in 10 years prompting the explosion of coffee chains started to meet the increasing demand. The supply and demand theory states that, an increase in demand prompts a rise in supply aimed at satisfying the market gap (Phaneuf & Requite, 2016). Entrepreneurs’ are always at the look of unexploited demand which when they discover as profitable, venture in to business to meet the demand.

The barriers to entry on the market are slightly low. New firms can enter the market without much challenge from already existing firms. However, it is worth noting that, coffee customers in Australia tend to prefer visiting chain coffee outlets making it slightly difficult for independent outlets to survive the turbulence of competition. New firms have to offer exceptional customer service and invest in advertising.

Income is directly proportional to consumption. Higher income among individuals is associated with increased purchasing power (Ready, et al., 2017).The rise in average income among Australians as a result of increasing economic growth, has led to increased coffee consumption. People’s drinking habits have also changed leading to a reduction in the traditional pubs and an increase in coffee uptake.

  • Would firms in the market making positive economic profit in the long run? Explain.

The coffee market in Australia operates under a monopolistic competition market structure. In this market, producers and consumers are many although producers tend to differentiate their products. The barriers to entry are also minimal such that in the short run, firms can make surplus profits. As more coffee chains enter the market, earlier firms start making normal profits. When companies differentiate their coffee and customer service, they benefit by increasing prices without losing sales since loyal customers would be ready to purchase their product even at higher prices up to a reasonable range. In the long run, conditions of entry will determine whether firms will make profits. In presence of surplus profits, more companies shall enter the market leading to a decline in market share enjoyed by existing firms (Lee & Wang, 2018). New entrants might raise cost of resources leading to a decline in profits. Therefore, as long as profits shall exist in the long run, more entries will stabilize at Zero profit and other companies withdraw from the market. Below is a graph of long run output and price of the industry.

OUTPUT

  • Would the impact of government subsidy to each existing firm change your answer in part (c) in the short run? Explain.

No. Subsidies are money paid by the government to producers or consumers per unit of product bought or sold. Subsidies operate like negative tax that promote production and increase supply (Miller & Benjamin, 2017).In presence of a subsidy, the sum of all income received by a producer from selling the product is equal to the sum paid by the consumer plus the amount of subsidy. When government pays a subsidy each existing firm, the firms would operate at lower production costs. Also, they would have the incentive and capability to produce more coffee. The subsidy would encourage new entrants to enter the market to exploit the subsidies offered by government (Bayramoglu, et al., 2018).Although the entry of new firms might reduce market share of existing firms, short run profits would be not be negatively significantly impacted. The gains originating from the subsidy would surpass the losses resulting from increased entrants. The short run profits would therefore be high. The answer in part (c) above would not change.

QUESTION 3

Suppose the tea market can be described by the following equations.

Demand: P=10-Q ………….. (I)

Supply: P=Q-4 ……………………. (ii)

Where p is the price in dollars and Q is the quantity in kilograms.

  • What is the equilibrium rice and quantity

Market equilibrium is the point at which the quantity demanded of a product is equivalent to the quantity supplied (Pomfret, 2016). The equilibrium quantity and market equilibrium price can be calculated by equating the supply and demand equations (i) and (ii) above and then solving the values of P and Q as follows;

10-Q= Q-4 hence; 2Q= 14 such that Q=14/2=7 kgs.

Replacing Q=7 in equation (i) above; we have P=10-7= 3 dollars

The equilibrium price and quantity is therefore 3dollars and 7 kilograms respectively.

Equilibrium price and quantity can also be obtained by plotting a curve as follows, such that the point of bisection of the demand and supply curve becomes the equilibrium point. From the graph below, the point of intersection of quantity demanded curve and the quantity supplied curve is point (3, 7). Therefore, we conclude that the equilibrium price is 3 dollars while the equilibrium quantity is 7kg. 

  • Suppose that the government grants a subsidy of $1 per kilogram of tea produced, what will the new equilibrium quantity be? What price will the buyer pay? What amount per kilogram including subsidy will the seller receive? What is the total cost to government?

What will the new equilibrium quantity be? 

The introduction of a subsidy implies that the producer obtains a price and the subsidy for every quantity produced. Original Qs=P+4 and Qd=10-P. with the introduction of the subsidy, Qs1= P+4+1=P+5

Equating Qs1 and Qd we have; P+5= 10-P

2P=5

P=2.5 dollars

Substituting P=2.5 in Qs=P+5= 5+2.5=7.5 Kilograms

Therefore, the new equilibrium quantity and price are 7.5Kg and 2.5 dollars respectively.

What price will the buyer pay?

The buyer pays the equilibrium price= 2.5 dollars

What amount per kilogram will the seller receive?

The seller receives the total amount found by adding the amount paid by the buyer and the subsidy.

Subsidy= $1, amount paid by buyer = 2.5 dollars

Pp= Pc+S= 2.5+1= 3.5 dollars

What will be the total cost to the government?

Subsidies increased government expenditure since the government pays a certain amount to the producer for every unit produced (Van den Berg, 2016). To find the cost of a subsidy program to government, we multiply the total quantity of the product produced and subsidy per unit.

CG = 7.5* 1= 7.5 Dollars

From this solution, it is worth noting that the subsidy led to an increase in quantity supplied from 7Kg to 7.5Kg. The price of tea also declined by 0.5 a value less than the amount of subsidy.

  1. Draw the demand and supply diagram of the tea market and indicate the results in parts (a) and (b) on it.
  • Draw the demand and supply diagram of the tea market and indicate the results in parts (a) and (b)

References

Bayramoglu, B., Copeland , B. R. & Jacques, J. F., 2018. Trade and Subsidies. Journal of International Economics, pp. 13-32.

Bernanke, B., Antonovics, K. & Frank, R., 2015. Principles of macroeconomics. New York: McGraw-Hill Higher Education.

Bos, D., 2014. Public enterprise economics: theory and application. New York: Elsevier.

Dabla-Norris, E. & Duval, R., 2016. Imf Blog. [Online]
Available at: https://blogs.imf.org/2016/06/20/how-lowering-trade-barriers-can-revive-global-productivity-and-growth/
[Accessed 2018 09 09].

Egan, M. & Gumaraes, 2017. The single market: Trade barriers and trade remedies. JCMS: Journal of Common Market Studies, pp. 294-311.

Ehrenberg, R. G. & Smith, R. S., 2016. Modern labor economics: Theory and public policy. Abingdon: Routledge.

Gopinath, G., Helpman , E. & Rogoff, K., 2014. Handbook of international economics. New York: Elsevier.

Hamilton, C., 2017. Import quotas and voluntary export restraints: focusing on exporting countries. In The Political Economy of Manufacturing Protection. Abingdon: Routledge.

Hong, G. H. & Li, N., 2017. Market structure and cost pass-through in retail. Review of Economics and Statistics. s.l.:s.n.

Lee, S. S. & Wang, M., 2018. The impact of jumps on carry trade returns. Journal of Financial Economics, pp. 23-67.

Miller, R. L. & Benjamin, D. K., 2017. Economics of macro issues. London: Pearson .

Phaneuf, D. J. & Requite, T., 2016. A course in environmental economics: theory, policy, and practice. Cambridge: Cambridge University Press.

Pomfret, R., 2016. International trade. Singapore: World Scientific Publishing Company.

Ready, R., Roussanov, N. & Ward, C., 2017. Commodity trade and the carry trade: A tale of two countries., 72(6), pp.. The Journal of Finance, pp. 2629-2684.

Van den Berg, H., 2016. Economic growth and development. Singapore: World Scientific Publishing Company.

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