Fall in Global Dairy Prices and Multiplier Effect.

Recently prices on Fonterra’s global dairy auction fell but analysts feel that this is not going to be long-term. The fall has been mainly caused by:

Supply increasing significantly relative to the demand – March, April and May tend to be very productive for northern hemisphere farmers as that is when they have peak supply figures. Furthermore over the summer in New Zealand we have had excellent growing conditions with soil moisture levels being very high for the time of year. This transfers into an increase in available feed for dairy units and increased milk output.

The graph below shows the Global Dairy Trade Weighted Average Prices and it is believed that this drop in prices is not a re-run of the global financial crisis when prices dropped to below US$2,000 a tonne. This was due to stagnant demand which does not seem prevalent today.

It is estimated that a US$1 difference in the milk price between seasons represents about $1 billion
in cash flow for Fonterra’s 10,000 supply farms. When you consider the multiplier effect this can translate to 4 times that for the rural sector as a whole.

The Multiplier

An initial change in aggregate expenditure can have a greater final impact on equilibrium national income. This is known as the multiplier effect and it comes about because injections of demand into the circular flow of income stimulate further rounds of spending.

Multiplier Process
Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realize an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation 1 ÷ (1-MPC)

You can also use the following formula which represents a four sector economy

MPS = Marginal propensity to save
MRT = Marginal rate of tax
MPM = Marginal propensity to import

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