Living in a rural area you tend to get a lot of free newspapers with a agricultural bent. Skimming the pages of NZ Farmer (March 28 2016) I came across a very informative article by Keith Woodford about European farmers expanding their value-add dairy production and its impact on New Zealand.
Up to April 2015 European farmers were protected by production quotas and the Common Agricultural Policy (CAP) which provided large production subsidies which led to over-production. At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector.
An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated opposite. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:
1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.
Production quotas in Europe were eliminated in April 2015 and from April to November European milk production increased by 4% with a 6% increase in December from the previous year. However, as with the reduction in subsidies in New Zealand in 1984, they will be a lot of pain for European farmers as their ‘safety net’ has now been taken away.
The Europeans are producing as much cheese, butter, infant formula and cream as they can, with cheese being more important than liquid milk. The Europeans are also selling increasing quantities of UHT and infant formula to China. With both products, they are out-marketing New Zealand.
Chinese infant formula statistics for 2015 show European countries with 78 per cent market share of imported product, compared to New Zealand at 8 per cent.
#1 – Holland – 34%
#2 – Ireland – 15%
The Europeans would like to decrease their production skim milk powder (SMP), but with butter and cream being profitable, they keep producing the SMP as a by-product. However, the European production of whole milk powder (WMP) has been drifting down in response to low prices.
The European producers have protection from some of the Global Dairy Auction process through their reliance on value-add products. Also, apart from Ireland, all European dairy systems are 12-month-a-year production systems. These 12 month production systems can lead to higher production costs, but they also lead to lower processing costs through better utilisation of processing infrastructure. This then feeds back into higher farm-gate prices.
The Europeans have been putting limited quantities of skim milk powder (SMP) into what are called intervention stocks. At the end of January 2016, there were about 50,000 tonnes of SMP in a public intervention store. The intervention quantities could reach a new limit of 218,000 tonnes over coming months. The main benefit of the SMP intervention is a smoothing of commodity prices. So if the price is too high stocks are released into the market and when they are too low authorities buy stock in order to reduce supply and therefore increase the price to a specific level.
European Farmers and the future
There is a good chance that in the longer term European milk production will further increase, as some farms become bigger and fewer in number. Poland has become one of the largest milk producers in the EU become a major milk producer with its flat terrain, very fertile soil, low feed and labour costs. Furthermore compared to other EU members it doesn’t have the pressure on land for residential use. Since joining the EU in 2004, the informal dairy sector is also still considerable in Poland, but the 2015 quota lift has seen these farms absorbed into the formal sector which in turn are expected to expand quickly without quota impediments.
For this longer term, the Europeans are not going to try and compete with New Zealand with WMP. Europeans regard WMP as an outlet for product with no other immediate use. And they know that, in low-priced volatile commodity markets for long-life products, they lack competitive advantage relative to New Zealand.
What a difference a year makes for Indian low cost airline Spicejet. On the verge of shutting down in December 2014 with $300m of debt with suppliers refusing to refuel planes unless paid upfront and staff not been paid their monthly salaries, the airline has made a remarkable recovery. Today it is filling 93% of available seats and has made a profit in the last 4 quarters.
What has been the cause of the turnaround?
- Aircraft fuel expenses dropped nearly 35 percent
- Demand has increased – compared to the previous year Indian airlines carried 20% more passengers in 2015.
- Negotiated better terms with aircraft-leasing firms
- Cut jobs and managers pay
- Scrapped unprofitable routes
Measures to reduce inefficiencies of Spicejet
- Reducing the time to second-tier cities and thereby making it possible to fit in an extra flight a day.
- Steel brakes on wheels of Boeing 737 were replaced with lighter carbon brakes
- In-flight magazines reduced – less weight
- Meals served in cardboard boxes instead of plastic trays – reducing fuel consumption
- Planes were filled with just enough fuel within safety margin
- Landing gear was deployed 8km from touchdown instead of 14km – reduce drag
- Taxi on the runway using just one engine – more fuel efficient
- Stocks of spares parts are now more readily available so planes spend less time on the ground
Although the airline still has a long way to go to reduce its debt its recent performance has enabled it to think about long-term expansion.
There is the oil cartel, OPEC, but little is written about FPAQ which is The Federation of Quebec Syrup Producers. The FPAQ was created in 1966 under the Professional Syndicates Act. Affiliated with Union des producteurs agricoles (UPA), it’s mission is to defend the economic, social, and moral interests of Quebec’s 13,500 maple syrup producers who operate 7,300 maple syrup businesses in 12 regional maple syrup producers’ unions. Each producer is subject to a quota and any excess syrup is put into FPAQ’s stockpile, and producers only get paid for it when it is sold which can be years later. Between 2010 and 2014 Quebec accounted for 72% of world production – see graph.
The FPAQ’s intention is to keep prices high and stable by limiting supply of syrup on the market. However there are concerns about FPAQ’s long-term viability:
- As with the oil industry the higher price has encouraged other suppliers to entry the market.
- Across the border the US has increased its maple harvest from 7.2m litres in 2012 to 12m liters in 2014. This may mean cuts in members’ quotas and stockpiling more syrup to maintain a higher price.
- With maple syrup becoming increasingly expensive substitutes are being sought in the from of toppings made from corn syrup.
- Supply is outpacing demand and FPAQ’s strategic reserve has increased to 25m litres which is equivalent to one year’s sales.
Saudi Arabia has been able to drive high-cost oil producers out of business by allowing the price of oil to fall. However the FPAQ don’t really have this option as the operating costs for maple syrup plantations are very low and US producers are unlikely to cease production like the high-cost oil producers.
A barrel of maple syrup from Quebec is worth more today than a barrel of crude oil. Producers are reaping the benefits, but not all agree with the tactics that whipped the supply chain into shape. Below is a very good video from The New York Times.
The commercial aircraft market has been dominated by Boeing (USA) and Airbus (EU) and according to Airbus’ Global Market Forecast 2015, in the next 20 years, passenger air traffic will grow annually at 4.6 percent driving a need for around 32,600 new passenger and freighter aircrafts. This duopoly has existed since Airbus introduced its long-range A330/A340 in the 1990’s when it challenged Boeing’s monopoly position. However, the Chinese are now challenging the duopoly’s market share by introducing its alternative to the Boeing and Airbus options. COMAC, a Chinese state-owned planemaker, has revealed its C919 plane as a competitor to the Airbus 320 and Boeing’s 737 although the C919 will not be ready for service until 2019.
Eventhough COMAC is state backed there are still significant barriers to entry for the commercial airline manufacturer.
- It is anticipated that the C919 fuel efficiency will not be a the levels of the newer versions of the Boeing 737 and Airbus A320.
- The Chinese have little experience in creating complex production systems and supply chains. Boeing research and development costs for the new Dreamliner, grew to $28 billion as a result of problems with its supply chain.
- They will need to improve their safety records in order to encourage sales. COMAC’s regional jet, the ARJ21, had its first test flight in 2008, but has yet to be certified because of poor wiring and cracks on the wings.
Are the Chinese actually trying to break the duopoly?
COMAC’s goal of breaking up the Boeing/Airbus narrow-body aircraft duopoly is a challenging ordeal but is this the motivation behind the C919? With China’s secret-capitalist economy, the central government likes to use American or European aircraft orders as a way of correcting a trade imbalance. Although they would still be importing the avionics and engines from around the world, the overall value of those components are insignificant when compared with a complete aircraft. China does need planes now and with the growing income levels of the economy there will be huge demand for air travel. But what is ironic is that Airbus already have a factory in Tianjin making the A320 aircraft although COMAC are realistic that new aircraft take significant time to put into service and therefore still require Airbus planes.
China has established itself as a economic powerhouse but they also want to be seen as having the innovative ideas and technological knowledge to challenge the established market. By producing a state-of-the-art aircraft they can announce their arrival on the world stage of innovation. The C919 is a pathway to achieving this.
HT to past student Shelalé Mazari for the image below. Tom Goodwin wrote a very interesting article on the battle for the consumer interface.
Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.
He states that since the Industrial Revolution there are complex supply chains including manufacturers – importers – wholesalers – franchises – retailers. However the rapid rise in technology has allowed a number of these parts of the chain to be removed.
Uber, Facebook, Alibaba and Airnb are companies with, what Goodwin refers to as, thin layers that sit on top of vast supply systems (where the costs are) and interface with a huge number of people (where the money is). The New York Times needs to write, fact check, buy paper, print and distribute newspapers to get their ad money.
Here is a great video from Tyler Cowen of Marginal Revolution fame in which he explains Price discrimination – Unit 2 in the CIE Economic syllabus. Price discrimination is common: movie theaters charge seniors less money than they charge young adults. Computer software companies sell to businesses and students at different rates, often offering discounts to students. These price differences reflect variations in the elasticity of demand for these different groups. When demand curves are different, it is more profitable to set different prices in different markets. We’ll also cover arbitrage and take a look at some examples of price discrimination in the airline industry
I alluded to in a previous post that one model of oligopoly revolves around how a firm perceives its demand curve. The model relates to an oligopoly in which firms try to anticipate the reactions of rivals to their actions. As the firm cannot readily observe its demand curve with any degree of certainty, it has got to estimate how consumers will react to price changes.
In the graph below the price is set at P1 and it is selling Q1. The firm has to decide whether to alter the price. It knows that the degree of its price change will depend upon whether or not the other firms in the market will follow its lead. The graph shows the the two extremes for the demand curve which the firm perceives that it faces. Suppose that an oligopolist, for whatever reason, produces at output Q1 and price P1, determined by point X on the graph. The firm perceives that demand will be relatively elastic in response to an increase in price, because they expects its rivals to react to the price rise by keeping their prices stable, thereby gaining customers at the firm’s expense. Conversely, the oligopolist expects rivals to react to a decrease in price by cutting their prices by an equivalent amount; the firm therefore expects demand to be relatively inelastic in response to a price fall, since it cannot hope to lure many customers away from their rivals. In other words, the oligopolist’s initial position is at the junction of the two demand curves of different relative elasticity, each reflecting a different assumption about how the rivals are expected to react to a change in price. If the firm’s expectations are correct, sales revenue will be lost whether the price is raised or cut. The best policy may be to leave the price unchanged.
With this price rigidity a discontinuity exists along a vertical line above output Q1 between the two marginal revenue curves associated with the relatively elastic and inelastic demand curves. Costs can rise or fall within a certain range without causing a profit-maximising oligopolist to change either the price or output. At output Q1 and price P1 MC=MR as long as the MC curve is between an upper limit of MC2 and a lower limit of MC1.
Criticisms of the kinked demand curve theory.
Although it is a plausible explanation of price rigidity it doesn’t explain how and why an oligopolist chooses to be a point X in the first place. Research casts doubt on whether oligopolists respond to price changes in the manner assumed. Oligopolistic markets often display evidence of price leadership, which provides an alternative explanation of orderly price behaviour. Firms come the conclusion that price-cutting is self-defeating and decide that it may be advantageous to follow the firm which takes the first steps in raising the price. If all firms follow, the price rise will be sustained to the benefit of all firms.
If you want to gradually build the kinked demand curve model download the powerpoint by clicking below.