competitive market environment that Victorian Diary Giant operates by answering four questions in the case. Victorian Diary operates under the perfect competitive market. In the last few years, the firm has cut the milk prices by 8.5% making the new price to move to $4.50 per kilogram leaving farmers at break-even level because of the glut of the milk in the world markets. While 8.5% cut of price is relatively good, however, the struggling famers does not achieve much comfort from the new price.
Competition occurs when there is a rivalry among firms producing similar products. In the competitive environment, firms always try to take away the market shares of other firms. However, a perfect competitive market is the kind of market where firms are price taker. The following requirements operate in a perfect competitive market:
Firms operating in the market produce identical products,
There are no barrier to enter the market,
In the market, both producer and buyers are price takers,
There are large number of buyers and sellers.
Freedom of entry or exist
When the prices are generally high in the market, producers will expand the output because they believe they could earn more by expanding output,
On the other hand, when prices are generally low in the market, producer must reduce output because they believe that they would lose by producing more. (Andreu, Michael, & Jerry 1995).
Answer to Question 1
Pricing decision in perfectly competitive market is being determined by the interaction of demand and supply. Once prices are determined in a perfect competitive market, buyers and sellers have to accept the price if they want to buy or sell in a perfectly competitive market. Thus, all producers and consumers are price takers because they cannot influence the price.
As being revealed in the Fig 1, all firms producing milk within the industry are price takers. In the industry, the equilibrium market price is where the market demand is equal to the market supply.
Fig 1: Milk Perfectly Competitive Market
In the short run, the milk equilibrium market price is being determined by the model of interaction market demand and supply. Under the perfect perfection that milk is operating, firms could make super normal profits in the short run. As being revealed in the diagram in Fig 2, P is the market clearing price and this is the price that all firms should charge for their products. Since market price is constant for each unit of product sold, thus AR (Average Revenue) also becomes MR (Marginal Revenue). Thus, a milk production firm will maximize its profits when marginal revenue = marginal cost. As being revealed in the illustration in Fig 2, a firm maximizes its profits at output Q. At price
Fig 2: Milk Market Equilibrium Price
From the diagram, the area shaded is the firm's economic supernormal profit that firms make in the short run. The super normal profits are possible because the market price P. is greater than the average total costs. However, the Victorian Diary Giant is only making normal profits within the market because its total revenue is equal to the total costs. (TR=TC).
Answer to Question 2
Glut is a market situation where the quantities of goods and services supplied in the market exceed the quantity of goods and services demanded. However, the glut of milk in the market will cause supply to shift Qo to Q1 (See Fig 3). Typically, the glut in the market will make the price of milk to go down. The glut is a typically features in a competitive market competition. The super normal profits that firms are making in the short run will attract other milk firms to enter the market which will lead to the high supply of milk in the market. When there is a glut in the milk market, many firms will be making a loss because their total costs are greater than the total revenue making them to leave the market. However, the efficient milk firms will be able to make normal profits when there is a glut of milk in the market. This is illustrated in the case revealing a glut world market of milk leading to fall in the price of milk by 20% within the last year. The effect of the glut makes Victorian Diary Giant to break even in the market and record normal profits. As being revealed in Fig 3, the glut will make the price of milk to fall from P. To P1 and a single efficient firm will only be able to make normal profits.
Fig 3: Impact of Milk Glut on the Market
Answer to Question 3
A legal minimum price is a form of price control that governments use to put restriction on the price of goods and services. The goal behind implementing minimum price is to maintain affordability of prices of goods and services. One of the forms of price controls is minimum price. However, this paper argues against a legal minimum price that Minister of Agriculture may want to impose on milk.
All milk firms at Victoria in Australia operate under the perfect competitive market where firms are price takers and should not charge above or below the price fixed by the market. The decision of Minister of Agriculture to fix a minimum price for milk may serve as a disadvantage to many farmers. As being revealed in the case, Victorian Diary Giant has already cut its farm-gate milk price by 8.5%, and charging at $4.50 per kilogram. This is the price that makes the firms to break-even and makes normal profits. Introducing a minimum price below $4.50 per kilogram will make the company to face challenges in breaking -even because the firm total costs will be higher than the total revenue. Typically, the company may run at loss because the company may not be able to make a normal profit again.
The economic theory argues that a legal minimum price control des not always accomplish its objective. Price control system always distorts the free market mechanism and thereby distorts allocation of scarce resources. Setting minimum price for the goods and services will lead to the shortage of goods and services in the market because setting prices below the equilibriums prices will lead to a situation where there would be a shortage in the market because the demand will be higher than supply. Thus, Minister of Agriculture may not be able to achieve its objective because the demand of milk will be higher than the supply of milk. Thus, milk firms will not be able to produce milk to meet demand. (Hugh, 2008).
Since the government is setting a legal minimum price below the market equilibrium price, the policy will discourage many farmers to produce milk leading to shortage of milk in the market. Moreover, introducing a legal minimum price will lead to a situation where firms will embark on the layoff of workers since the total costs are above the total revenue. Typically, the policy will aggravate unemployment situation because many firms may embark on the mass layoff of workers because they are running at a loss. Moreover, a legal minimum price policy may lead to quality deterioration where farmers may produce low quality milk to decline costs. Thus, consumers will pay the higher price for low quality milk. If the government intends to enforce farmer to produce high quality milk at a legal minimum price, farmer will be forced to produce fewer products leading to product shortage in the market.
Thus, this paper does not support a legal minimum price for milk that Minister of Agriculture intends to introduce.
Answer to Question 4
A possible alternative program that government could implement to increase the price that farmers receive for the milk production is to use price…