Review the article by John Durie ( The Australian June 28, 2012 12:24PM) about the glut in the world milk market and apply basic economic theory to answer questions relating to achieving market equilibrium, the impact of a glut on the equilibrating process and your recommendations if you were the relevant minister responsible for this industry.

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Unit code:ECO11 Unit name:Principles ofEconomics (wordcount 1259)
Assignmentno.2 Due date: 1st
April 2013.
Assignmenttopic (as stated in the Course outline and assignmentbook):Read the following excerpts from the article
“Glut to blame for farm-gate milk price falls not big supermarkets” by John Durie published in the Australian on
June 28th 2012 and answer all the questions.
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3. 3
Glut to blame for farm-gate milk price falls, not big
supermarkets
John Durie The Australian June 28, 2012 12:24PM
VICTORIAN dairy giant Murray Goulbourn has cut farm-gate milk prices by 8.5 per cent to $4.50
per kilogram which leaves farmers at break-even levels due to the glut of milk on world markets.
Milk prices have fallen by 20 per cent over the last year so the 8.5 per cent cut from Murray
Goulburn is relatively good but that isn’t much comfort for struggling farmers.
Q.1:
(Diagram1)
Diagram 1 represents a typical supply and demand curve in a perfectly competitive market.
Supply curve (S) graphically characterises the law of supply, which states that - ‘cet par’ or
Ceteris Paribus (meaning - all other things being equal) - suppliers are “willing and able to sell
more products at a higher price than they would at a lower price” (Bajada et al. 2012, p. 43).
Conversely, curve (D) represents the law of demand and is based on the assumptions that ‘cet
par’, demanders (consumers) will; (a) buy more products at lower prices than at higher prices;
(b) consumption is subject to ‘diminishing marginal utility’ in any given period & (c) that both
the ‘income’ and ‘substitution’ effects will apply.
The point at which the supply curve (showing a direct relationship between price and quantity)
and the demand curve (showing an inverse or negative relationship between price and quantity)
cross, establishes the milk markets ‘equilibrium price’. When a line is drawn from this point
across to the vertical ‘Y’ axis (price), equilibrium price ‘Pe’ is confirmed. Using this same
method down to the ‘X’ axis (quantity supplied), equilibrium quantity = ‘Qe’.
Only at this point will a surplus or shortage of product in the market place be averted. As
defined by Bajada et.al (2012, p.47 – 48), a surplus occurs when higher selling prices
encourage sellers to produce more product; but buyers are subsequently discouraged by the
same higher price and purchase a lower amount of the quantity produced at that price. A
shortage is where the lower prices encourage higher demand for product at that price; however
producers are discouraged to produce a large enough quantity to service that demand at the
same lower price.
Supply & Demand of Milk.
D
P
Q0
Price($perkg)
Qty Supplied (000 kgs/week)
Equilibrium
surplus
shortage
S
Pe
Qe

4. 4
Q.2:
(Diagram 2)
A ‘glut’ as defined by the Merriam-Webster website (2013), is to “flood (the market) with
goods so that supply exceeds demand”. For the market in question, diagram 2 shows a shift
rightward of the supply curve illustrating the excess of milk. This change in supply results in a
change to both the equilibrium price and quantity. An increase in milk supply causes the
equilibrium price to decrease; as shown at Pe to P1. This also results in an increase in the
equilibrium quantity as shown at Qe to Q1.
The move from Pe to P1 and Qe to Q1 highlights what is termed the ‘equilibrating process’. It
shows how a market is able to find balance between supply and demand forces. As diagram 2
illustrates, when supply increases (S to S1), the market experiences a period of disequilibrium
resulting in a surplus. To correct this, the price must decrease for demand to balance with
supply thus re-establishing equilibrium (P1 - Q1). If pricing at Pe held firm and demand stayed
constant, a surplus would result as shown by (Q2).
Q.3:
If I was Minister for Agriculture in Victoria, I would reject this request from the Victorian
Dairy Farmers Association. Imposing a legal minimum price where prices are fixed above
equilibrium price, would hurt the dairy farmers in the long-term. Sometimes called a ‘price
support’, it is designed to assist suppliers where society feels that the natural market forces
have failed to establish a fair equilibrium price to provide suitable levels of income. In other
words ‘P1’ as shown in diagram 2, is only enough for the dairy farmers to reach break-even
levels. By implementing a higher minimum price point (Pe), the Victoria government would be
hoping it helps dairy farmers in obtaining a higher return.
The merits of this sound great, however it is important to review the implications of what this
may cause as a result. Looking again at diagram 2, we can see that based on the supply
schedule of S1; any price set above the natural equilibrium price of (P1) – in this case (Pe) –
will only lead to a continued surplus of milk in the market as evidenced by the distance
between QeQ2. Why? Because the law of demand tells us that, ‘cet par’; “demanders normally
buy more product at a low price than they do at a high price” (Bajada et al. 2012, p. 36).
Supply & Demand of Milk.
D
P
Q0
Price($perkg)
Qty Supplied (000 kgs/week)
S
Pe
Qe
S1
Equilibrium
P1
Q1
surplus
Q2

5. 5
Q.4:
(Diagram 3)
There are a number of ways the government could increase the price of milk in the market.
However the question being asked is what programs can the government implement “to
increase prices farmers receive in the market”. There is no point raising the price of milk if the
demanders are not willing to pay it. If buyers do not buy, sellers do not receive. Any program
suggested must take into account its effect on demand. A continued surplus would simply force
prices down in order to shift product; and fail to achieve improved returns for the dairy farmers.
It is with this in mind that the following recommendations are made.
The first is a ‘supply quota’. This is a supply control measure that limits the volume of milk
produced or supplied to market. Referring again to diagram 2; by restricting supply ‘cet par’,
you shift the supply curve (S1) back towards (S) and in balance with demand schedule (D). Any
quantity of milk over the specified quota is usually penalised by a forced minimum price.
Should any quantity be supplied over (Qe); the minimum price at (Pe) would apply. In this
case, the shift of the supply curve left works to drive the price of milk back up towards the
price equilibrium (Pe).
The second option would be to introduce programs that would lift demand for milk in the
market by developing other uses for it. In creating another demand stream – e.g.; as a natural
raw material substitute in the production of skin care products – the government tries to lift
demand to match or reduce the gap, between the equilibrium price and the supported minimum
price. The goal is to thereby reduce the size of the surplus. Diagram 3 shows the best possible
outcome from this initiative. By increasing demand, the Victorian government shifts the
demand curve rightward (D1) and increases market price to (Pe), returning the market to
equilibrium.
The final option is for the government to subsidise the dairy farmers by purchasing any surplus
milk. Here, the government is essentially meeting the shortfall in demand created by the higher
minimum price point (Pe), to keep the market at equilibrium. The shortfall here is shown as the
distance between QeQ2. This is normally a last resort mechanism for a government should the
above 2 previous options fail to address the issue effectively.
Supply & Demand of Milk.
D
P
Q0
Price($perkg)
Qty Supplied (000 kgs/week)
S
Pe
Qe
S1
Equilibrium
P1
Q1 Q2
D1

6. 6
The article by John Durie (2012), suggests that the excess of milk in the market is to blame for
the fall in its market price. By tackling the supply and demand quantity problems caused by this
excess, the natural market forces will find an appropriate equilibrium price. The legal minimum
price point suggested in question 3 is a direct change to the price of the product itself along a
stable supply or demand curve. It does not result in a change of either the supply or demand
schedules. Using the current example and referring to supply curve (S1) and demand curve (D)
in diagram 3, it would not be logical to have the dairy farmers increase the market price in
order to improve their returns, without it having a quantity reducing effect on demand that
would result in a surplus. The previous three options are all associated with changes to ‘non-
price determinants’ and work at increasing either the supply or demand schedules of milk that
look to bring the market back into balance.
Reference List:
Bajada, C, Jackson, J, McIver, R, Wilson, E 2012, Economic Principles,3nd edn, McGraw Hill, North
Ryde, Australia.
Durie, J 2012, ‘Glut to blame for farm-gate milk price falls, not big supermarkets’,The Australian, 28
June, viewed 15 March 2013, <http://www.theaustralian.com.au/business/opinion/glut-to-blame-for-
farm-gate-milk-price-falls-not-big-supermarkets/story-e6frg9io-1226411003410>.
Merriam-Webster 2013, viewed 20 March 2013, <http://www.merriam-webster.com/dictionary/glut>.
Appendices/Enclosures:
Adams, K 2007, Microeconomics, University of South Australia.