Economic Concepts and Decision-Making - Carlton Vineyard - Case Study Example

Economic Concepts and Decision Making and Introduction The vineyard business has been boomingin Southern Australia. The region is known for its production of high quality grapes. The vineyards in Southern Australia contribute more than 60% of all wine production in Australia which is estimated to be 750 million liters per annum (Oag, 2014). Most of the produce is exported with only 20% consumed locally. A survey conducted in 2012 established that there are approximately 100 vineyard firms operating in Southern Australia producing the different grape varieties. The popular varieties produced in the Southern Australia are Shiraz, Merlot, Pinot noir, and Reisling (Barkley and Barkley, 2013). This paper highlights a hypothetical situation of a firm operating in Southern Australia. The firm will be named Carlton Vineyard. During the farming season the industry’s vineyards have all recorded low fruit set and the rainfall has also been insufficient. The fruit set is part of the grape’s growth cycle. It occurs just after flowering and involves the development of a seed. In this stage, too, the grape berry forms; its work is to protect the seed. These two processes are extremely crucial in determining the crop yield (Creasy and Creasy, 2009). If the processes fail, the crop is said to have had a low fruit set. The climate, especially the amount of rainfall, humidity and temperatures, affect the yield too. Creasy and creasy (2009) observe that low humidity, extremely high temperatures and low rainfall levels lead to low grape yields; consequently, a reduction in supply. This paper, built on this premise, will investigate how the change in factors of production and climatic condition affect a grapevine firm in Southern Australia with a view to applying the various economic principles and concepts. Demand and Supply The low fruit set and low level of rainfalls will affect the amount demanded and supplied in the market. Supply refers to the amount of grapes that the firm will be willing to sell at a particular price (Taylor and Weerapana, 2007). The low fruit set and low rainfall will reduce the amount supplied. This, in turn, will cause a relative increase in demand as there will be a shortage in quantity supplied (Tucker, 2012). The shortage and the ability of Carlton Vineyard to take advantage of the low yields will determine whether the firm will be profitable. The market structure, as discussed later on, will also influence the firm’s decision making and profitability in the long run and short run. For this situation to be effectively assessed the non-price factors affecting supply will have to be considered. The impact of low fruit set and low amount of rainfall on demand Low fruit set and low rainfall will increase the demand for grapes. This is because the firm will be able to supply the same amount of grapes at a higher price. Low fruit set means that the firm will have to use advanced technology to make up for the reduced yields. Low rainfalls will necessitate the firm to employ the various irrigation techniques to water the crops which translate to more production cost. The effect of these measures is that the demand curve shifts right (Cook and Healy, 2001). A shift in demand occurs when other factors affecting demand, apart from price, record an unfavorable change. Depending on how the firm was prepared for those unforeseen circumstances the firm may be able to take advantage of the situation to make abnormal profits or may just make losses just like many other firms. Figure 1 illustrates a shift in supply. Figure 1 The demand will also be affected by the presence of substitutes and the buyers’ expectations. Currently, Carlton produces two varieties of grapes; Merlot and Pinot Noir. There are three other varieties produced in Eastern Australia. In the short run, the grapes and the wine markets have been established to be relatively elastic while perfectly elastic in the long run. Therefore, customers will not shift to other brands just yet until these two problems persist for a long time. In the short run Carlton Vineyard will be able to retain its market portion and stay profitable for as long as it has the relevant stock to cover its production cost (Hoag and Hoag, 2006). The longer it takes for the firm to figure out the solution the faster its market share will be dwindling. Also, depending on the buyers’ perception of the situation, the firm may be able to retain its market share or not. Wine consumers are particularly sensitive about their products and brands making them less likely to change their brands. If they perceive the problem as temporary they will not shift to competitors’ brands and the firm will be able to stay in business (Oag, 2014). The impact of low fruit set and low rainfall on supply As noted earlier, low fruit set and low rainfall have a general effect of reducing the supply of grain in the market. Low fruit set will increase the cost of production as better technology and remedial measures will have to be taken to increase the yield. It means that the amount supplied will be less than what was anticipated. Low rainfalls, on the other hand, will also increase the production cost and reduce the amount of grapes supplied. This is because the firm will incur extra cost in irrigation. These two factors will have the effect of shifting the supply curve left as illustrated in Figure 2. Figure 2 A shift in supply occurs when there is a change in other factors affecting supply other than price (McEachern, 2012). These factors, in this instance, include the prices of related commodities, the price of farm inputs, technological advancements, and the government policies among others. The price of related commodity will affect the amount of the brand of grape supplied. In the short run, Carlton will not be able to change its line of production. Grapes’ farming is highly inelastic (Barkley and Barkley, 2013). If the low fruit set subsists only for some varieties of grapes then the firm may be forced to go out of the market because it cannot readjust fast enough and re-enter the market using another variety. As for government policies, the Australian government has been on the forefront of promoting grapevine farming. It is offering subsidies to firms to use irrigation to increase their production when the rain fails. In Australia, drip irrigation is the most widely used irrigation method. In Southern Australia, particularly, the government has made it possible for firms to use furrow and under-vine sprinklers by making the area an irrigation district (Oag, 2014). Apart from irrigation, the government also aids the firms in vine nutrition and pest management by subsidizing the cost of fertilizers and drugs. This way, more grapes are produced, majority of which is exported. The interaction of the shift in demand and shift in supply pushes the equilibrium point upwards. Market Structure Carlton Vineyard operates in a monopolistic competitive market. A monopolistic competitive market is one where there are many buyers and sellers in the market but the products being sold have been differentiated. In this type of market structure the firms obtain their market competitive advantage by differentiating their products (O’Connor, 2004). Carlton Vineyard produces Pinot Noir and Merlot, a few of the popular varieties of grapes grown in Southern Australia. In this region alone, there are over 100 vineyard firms (Creasy and Creasy, 2009). This means there are many buyers and sellers in the market. A firm, therefore, cannot control the market pricing like in the monopoly market structure. But the firms are also not powerless; they have a small degree of control (Sexton, 2012). But due to this less-than-full control, the customers perceive this market structure to be a non-price competitive market. They tend to look at other factors other than price that affects supply. The price, therefore, hardly affects the supply of commodities and will not be considered in this analysis. Given the number of players in the industry Carlton Vineyards cannot make abnormal profits in the long run even if it is in a position to do so. This is mainly because there are few barriers to entry and exit into the market. Therefore, if Carlton Vineyard was prepared for such an eventuality or took measures to mitigate the detrimental effects of low rainfall thereby giving the firm a competitive advantage over other firms, it still cannot make supernormal profits in the long run. The firm may have prepared for such an event by having stores full of grapes or by using irrigation to water the vineyard therefore maintaining a reasonable supply in the market unlike its competitors. In the long run, for a monopolistic competitive market, just like in a perfect competitive market, a firm can only make the economists normal profit (Taylor, 2006). The monopolistic market structure and perfect competitive market structures have almost identical long run trends. There are only two differences; the monopolistic market has heterogeneous products and the competition is not centered on price unlike perfect competition. For a firm in a monopolistic competitive market the profits and income equal the cost such that the firm only breaks even. The economic profit amounts to zero in the long run as the marginal revenue equals the marginal cost. But in the short run Carlton Vineyard can make supernormal profit because the period is too short for other firms to enter the market and take advantage of the price (Cullen and Parboteeah, 2009). Shutdown Due to the low fruit set and the low rainfall the cost of production for Carlton Vineyard will increase. Since the production has decreased yet the cost has increased the total cost and the average variable costs will both increase. When the price of the grapes per unit equals the average revenue but is less that the average cost that was used to produce it then the firm in a monopolistic market should shutdown in the long run and wait for the production cost to decrease (Boundless.com, 2014). This is illustrated in Figure 3 at point B where the AR=MR< AVC. If the production cost, as a result of irrigation and use of other technologies to increase production, increases such that the average revenue for Carlton Vineyard is less that the average variable cost in all output levels then the best option will be to shut down the business for the time being. Figure 3 Price Elasticity of Supply Even though the price is not a major determinant in a monopolistic market it still influences a firm’s performance and decision making. Price elasticity of supply generally measures the sensitivity of a products quantity supply with regards to changes in price. It examines the responsiveness in the quantity of the grapes that will be supplied if its market price increases or decreases by one per cent (Taylor, 2006). The time to respond is a great determinant. Elasticity of the product is determined by the ability of the producer to respond to changes in pricing. The faster the producer responds to such a change the higher the elasticity, and the reverse is also true. The law of supply dictates that the producer of goods will supply goods in the market at the best price there is. An increase in the price of the commodity, therefore, increases the quantity supplied. In this case, Carlton Vineyard could respond to changes in prices by supplying the produce it had in store because there is no time to grow other grape trees. If there are none then the firm’s elasticity will be said to be inelastic. The aggregate elasticity measures of the different firms in the market will determine the industry’s price elasticity of supply (Tucker, 2012). The other factor that may affect Carlton Vineyard price elasticity of supply is its excess capacity. This relates to the firm’s ability to produce extra capacity. Low fruit set will cause a shortage in supply as the quantity demanded will be more than that supplied. If the firm has extra resources or factors of production then it can take advantage of the changes in price and be able to make supernormal profits in the short run. If Carlton Vineyard has extra resources that can quickly be mobilized then the firm can be said to have an elastic price elasticity of supply. The complexity of the process will also determine whether the firm has price elasticity. Grape growing is a complex undertaking which requires significant time and material resources investment. It is therefore going to be hard for the firm to take advantage of the price changes because of the complexity of production. All the firms will have an inelastic curve as far as the complexity of production is concerned. Conclusion All commercial businesses have a goal of making a profit from their operations. In order to make profit, a firm must ensure that it is operating at its optimal capacity so as to enjoy the economies of scale, reduce production cost and maximize its profits. The firm must, therefore, carefully analyze some of the factors that might affect its supply and demand of the product, the elasticity of the product, the type of market structure the firm is operating in and the shut down point. All these factors and others, notes O’Connor (2004), if taken into consideration, should enable the firm to make better managerial decisions geared towards profit making. References Barkley, A., and Barkley, P., 2013. Principles of agricultural economics. London: Routledge. Boundless.com., 2014. Shutdown case. Boundless, [online] Available at: [Accessed on 24th February 2014] Cook, M., and Healy, N., 2001. Supply side policies. London: Heinemann. Creasy, G., and Creasy, L., 2009. Grapes. Sydney: CABI. Cullen, J., and Parboteeah, P., 2009. International Business Strategy and the Multinational Company. New York: Routledge. Hoag,A., and Hoag, J., 2006. Introductory Economics. London: World Scientific. McEachern, W., 2012. Contemporary economics. Chicago: Cengage Learning. O’Connor, D., 2004. The basics of economics. London: Greenwood Publishing Group. Oag, D., 2014. Grape production in Australia. FAO, [online] Available at: [Accessed 24th February 2014] Sexton, R., 2012. Exploring microeconomics. New York: Cengage Learning. Taylor, J., 2006. Principle of economics. New York: Cengage Learning. Taylor, J., and Weerapana, A., 2007. Economics. New York: Cengage Learning. Tucker, I., 2012. Microeconomics for today. New York: Cengage Learning. Read More