1. Explain your understanding of the concept ‘factors of production’ in the context of producing wine. Discuss also how resources are allocated in a market-based (capitalist) system – and whether this leads to economic efficiency compared to a command-and-control system.
2. Explain your understanding of the concepts ‘substitutes’ and ‘complements’ in relation to Australian Shiraz. Discuss also the concept ‘elasticity’ and how this would change if the market was defined as ‘Australian Red Wine’ rather than ‘Australian Shiraz’.
3. Show the impact of the frost on a winery producing Australian Shiraz using the firm cost diagram. Show Average Total Cost, Average Variable Cost, Marginal Cost and Marginal Revenue. Assume a competitive market.
4. Show the impact of the frost on the market for Australian Shiraz, using the market demand and supply diagram. Assume a competitive market.
The term “factors of production” is an economic concept, which represents those inputs that are required in the production process to earn economic profit (Nord-Larsen, Sevel and Raulund-Rasmussen 2015). To produce wine, producers require some factors of production as well. Those factors are weather, climate and soil.
In market based (capitalism) system, resources are allocated according to the decisions of individual consumers and producers. Resource allocation is an important concept of economics and can be determined with the help of three basic concepts that describe about amount of products to be produced, process of production and purpose behind it (Xu, Tihanyi and Hitt 2017). Market demand and market supply help producer to determine the amount of product to be produced. The production process takes decision regarding input allocation. The last concept deals with distribution of products related to money income distribution. Money income depends on the quality, quantity and various forms of resources along with product prices (Rosinger, Taylor, Coco and Slaughter 2016). Hence, the distribution of finished products depends on ability and willingness of consumers for paying market price.
Economic efficiency can be differing between capitalist economy and command-and-control system. In pure capitalism, individual firm owns productive resources and can be arranged according to its requirement. This system chiefly concentrates on three Ps, which are, profits, prices and private property (Rose-Ackerman 2017). The laissez-fair system can be observed within capitalist economy where producers through producing products and selling those at profitable prices can earn economic efficiency. This it can be said that this system can earn economic efficiency along with output stability, economic growth and employment. On the other side, in command economy community controls interest of workers to work while their self-interest cannot play any role. As the government takes entire decisions regarding production process, economic inefficiency can be seen over here (Roemer 2015). This happens as producers receive incentives from the government without facing any competition.
The term “substitute product” for a particular item implies that it has other similar products produced from other industry that can provide equal benefits to the buyers. Thus, a consumer has alternatives to select any good among all to fulfil certain requirements (Duan, Yao and Huo 2015). Hence, when price of one-product increases, demand for its substitute products increases while the opposite situation can also be occurred when price of the product reduces. This is also true for Australia Shiraz. The country has large varieties of planted grape. Thus, other verities like Grenache and Semillon and Cabernet Sauvignon can be considered as substitute products of Australian Shiraz.
Complementary product occurs when demand of it increases when price of its related product decreases. On the contrary, if the price of a product increases, demand for its complementary decreases as well. Thus, price of a product and demand for its complementary product has negative relationship (Li, Shao and You 2017). Australian Shiraz has also complementary products in market. Grape is the essential complementary product of Shiraz. Hence, higher price of this fruit can increase the price of Shiraz and vice versa.
The concept ‘elasticity” measures changing aggregate quantity demanded for a product when any one of the variable changes. Those variables are own price of this product or price of its relative commodities like substitute and complementary products or income of consumers (Clastres and Khalfallah 2015). The Australian Shiraz is one of the well-known Australian Red Wine across world. However, the red wine market has other substitute products of Australian Shiraz, such as, cabernet Sauvignon and so on. Hence, the impact of cross price elasticity can be seen over here. Thus, due to lower production of Shiraz grapes, price of Australian Shiraz can be increased in market and this can further increase the demand for other Australian red wines.
The frost has influenced winery production of Australian Shiraz by large extend through changing is cost pattern. Hence, this situation can be analysed with the help of various cost curves under perfectly competitive market. Due to lower production of grapes, price of raw product has increased and this in turn can increase total production cost of Australian Shiraz (Azevedo and Gottlieb 2017). Moreover, number of total output can also be decreased further due to lack of raw materials. Thus, average total cost (ATC) of this product is going to increase further. On the other side, raw materials are considered as variable products, its costs are referred as average variable cost (AVC) and consequently it increases further. As the rate of changing total cost can increase for per unit of production of Shiraz, marginal cost (MC) can be increased as well. Thus, all curves shift upward compare to before. On the other side, marginal revenue curve can shift upward as well. This is because, the wine company is going to charge hiring price for Shiraz due to its higher cost of production (Cullen and Mansur 2017). Consequently, the company can earn comparatively higher revenue. The following diagram has represented shifting of all curves.
Figure 1: Shift in cost curves
Source: (created by author)
In above figure costs curves are shifted in the upward direction, which are represented by diagrams drawn with red colours. The initial average total cost curve is shown as AC1 while initial average variable cost curve and marginal cost curve are represented by AVC1 and MC1 curve. In addition to this, initial marginal revenue curve is shown by MR1 curve. However, after increase in costs, the new ATC curve becomes ATC2. Moreover, new AVC, MC and MR curves are represented as AVC2, MC2 and MR2, respectively.
According to figure 1, entire cost curves and revenue curve for a firm of Australian Shiraz have increased and consequently have shifted towards upward. Under perfect competition, an industry consists with large number of firms. Due to huge fall in production of grapes, almost all Shiraz producing firms are affecting adversely and this in turn has affected market supply curve (Borenstein, Bushnell and Wolak 2017). Thus, from this phenomenon it can be said that frost has adversely affected the market of Australian Shiraz through changing market supply curve and demand curve. Due to lower production of grapes, production of Shiraz hampers and this further shifts market supply curve of this red wine to the left. On the other side, producers charge higher price as cost of production increases. However, based on law of demand, consumers can intend to buy comparatively less amount of Shiraz as the market has other substitute products. Thus, higher price of Shiraz forces its market demand to reduce further (Jadidzadeh and Serletis 2017). This can change equilibrium price and output of the market for Australian Shiraz. This phenomenon can be seen with the help of following diagram.
Figure 2: Shift in market supply curve
Source: (created by author)
In figure 2, aggregate supply curve has shifted towards left representing lower amount of supply. Thus, in market of Shiraz, price increases from P0 to P1 while equilibrium output decreases from Y2 to Y1.
Figure 3: Shift in market demand curve
Source: (created by author)
In figure 3, aggregate demand curve decreases and this further shifts the AD curve from AD1 to AD2. Consequently, equilibrium price decreases and comes to its initial level while equilibrium level of output decreases more, that is, from Y2 to Y3.
Market failure within an economy occurs when it cannot allocate its products efficiently and freely. As a result, the economy experiences a net loss related to social welfare (Dunning 2015). In given article, market failure is also seen where the government has implemented labelling laws on food businesses. Due to this, each company bears excess costs for creating and changing packaging systems of their products. However, according to this article, the government has implemented those policies based on some economic justification. The chief focus of the government of any country is to spread social welfare among citizens. This also happens in Australia when a hepatitis A spread in 2015 due to imports of frozen berries (Insch and Jackson 2014). Thus, the Australian government tried to make it clear to its citizens regarding source of importing production into this country. Thus, according to them, new labelling can provide better to consumers about the product details. As a result, consumers can decide that whether they can use those products or not.
Those policies have increased costs for every Australian company, as those companies are required to change their labelling. Thus further makes food business organisations unhappy. According to the Food South Australia, the entire business cost within this country can increase by large amounts while those firms cannot pass these costs to their consumers through charging higher prices. Thus, only food business organisations will only bear those costs. There are many entities, which produce and sell large wide range of products. Thus, they make various types of packages for their different types of foods. However, After changing this labelling law, those companies require to change huge number of labelling and that can be very costly for them. As, most of the food organisations operate under small and medium size scales, it can be very difficult for them to follow these policies within certain time period.
However, with implementing those policies, the government cannot prevent any negative consequences within the economy. According to the Health experts of Australia, these new level cannot provide proper information to consumers of this country. Those labels only state that whether those foods are producing within Australia or not (Newman, Turri, Howlett and Stokes 2014). However, it becomes difficult consumers to guess about sources of remaining ingredients from where they are coming from. Hence, without receiving proper information, consumers cannot take proper decisions that whether they can buy those or not. As a result, negative impacts can rise within economy like before.
The government can take alternative approaches that can be implemented to reduce negative impacts from importing foods items within economy. For instance, the government can implement proper health guide to their citizens through conducting various campaigning. On the other side, the government can restrict food imports from various foreign countries from where health diseases occur (Cichero et al. 2017). Moreover, the Australian government can adopt various research and developments to observe that whether the country can produce those foods within the country or not. If the country can adopt modern technology during production process then it can be easier for the government to reduce imports of foods from other countries.
In economic framework, there exist different market forms like that of monopoly, perfect competition, monopolistic competition, oligopoly, each varying in the aspects of number of sellers, buyers, market power distribution, nature of the product or service and also the barriers present in entry and exit aspects of the concerned market (Dixon et al. 2012).
In this context, the perfectly competitive market and the monopoly market are the two most prominent ones. In the competitive market, there exists many buyers and sellers, which in turn indicates towards the presence of equal distribution of market power, knowledge and other attributes and in this market both the buyers and the sellers are price takers.
According to the “Invisible Hand” theory of the Classical Economist, Adam Smith, the competitive forces in the market act in bring the demand and supply forces at par with each other and the presence of this competitive environment helps in reducing the self-interest of all economic agents, which in turn, is a socially desirable attribute (Wetzstein2013). In this context, in a perfectly competitive market, due to the presence of free entry and exit, the presence of excess profit in the market attracts new firms, thereby increasing the supply and reducing the price and vice versa. The products sold being perfectly homogenous, leaves no scope of individual bias of the buyers. Thus, any super-normal or sub-normal profit in the market is eradicated in the long run, and the equilibrium for the firms occur at the point:
P = MC (P being the price of one unit of the product and MC being the marginal cost of production of additional unit of the concerned product).
This in turn leads to both allocative as well as economic efficiency in the long run in the perfectly competitive market.
On the other hand, the monopoly market is one where there is one seller and many buyers, the seller thus enjoying market power and decision-making capabilities. The seller being a single operator, tries to maximize profit and thus, produces only that much amount of commodity which maximised its profit (Rios, McConnelland Brue2013). The equilibrium occurs in the market at the point where P is equal to the Marginal Revenue of the sellers:
In this situation, the buyers suffer due to the lack of economic efficiency. However, in this market due to the presence of a single seller, the same can enjoy economies of scale, thereby producing at increasingly lower costs as their production increases:
Thus, not always the perfectly competitive market is efficient over the monopoly market. This is because, the aspects of economies of scale (which indicates towards higher cost effectiveness in production) is not present in the former but is present in the latter (Halland Lieberman 2012). The former also does not have the provision of counting externalities which also hampers its efficiency. However, in terms of economic and productive efficiencies in a general framework, the perfectly competitive market is found to be more efficient than that of the monopolistic market.
The prosperity of a country and the welfare of residents of the concerned country depends on the different social, political and economic aspects of the country. Of these, the economic factors play considerably important roles as much of the monetary welfare, consumption pattern, purchasing capabilities and overall living standards of the residents of the country depends on the same. The macroeconomic policies taken by the government of the different countries play crucial roles in this aspect of ensuring economic progress of the countries over the years (Mankiw2014).
In this context, one of the primary objectives of the macroeconomic policy framework of any country is that of ensuring that the economy of the same experiences sustainable growth patterns with time. The economic growth of a country, in general refers to the increase in the productivity of goods and services as well as monetary growth for per head of the population of the country with time. Focussing on increase in the economic growth is required for the overall progress of the economy (Heijdra2017). However, economic growth should not be the only objective of the macroeconomic policy framework of the government of any country as the growth of the economy does not necessarily indicates towards the overall increase in the overall welfare of the population of the country. There are other aspects which are required to be considered to ensure overall development of the economy as well of the population. Thus, the other objectives which should be taken into account by the macroeconomic policy frameworks are as follows:
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