Floor pricing of wood in Australia - Essay Example

Floor pricing of wool in Australia The paper deals with the economic mechanism of imposing floor price in the wool industry in Australia from the period 1974 to 1991 which brought with it severe agricultural financial disaster with reference to the book, Breaking the sheep’s back by Charles Massey a wool grower and merino ram breeder in New South Wales. Demand-supply analysis is incorporated in order to realize the outcome of the imposition of floor price. Alternative policies are recommended which the Australian government could have adopted so that intensity of the disaster would have been lower.

Australia is well known for producing the world’s best quality woolen fiber that is the Australian merino wool. Australian wool industry was quite booming during 1950-1951 and during that period Australia was said to be ‘riding on sheep’s back’. But the scenario changed and the wool prices fell drastically and revenues squeezed. In order to stabilize the situation, from 1971 a Wool Deficiency Payments Scheme functioned for two years. But after that within 1974 and 1991 the Australian Wool Corporation (AWC) introduced a minimum reserve price with the aim of stabilizing the future wool price movements.

The idea was to purchase wool which did not achieve the agreed floor price and then selling the wool later in times of high demand (Australian Bureau of Statistics n.d.). Floor Pricing & Australian wool industry Floor pricing Sometimes the government may legally fix the minimum price at which the sellers may sell a particular good or service. Such price is known as floor price or the minimum support price. Floor price benefits the supplier of a good or service. Floor price is fixed to assure the producers that they would get a remunerative price for their product.

The floor price will motivate the producers to produce more by ensuring that they will get a minimum reasonable price for their product. A diagrammatic explanation below will show this: In the above diagram E is the equilibrium corresponding to the intersection of the demand and supply curve DD and SS respectively. OP0 and OQ0 are the equilibrium price and quantity respectively. Now if the government fixes the minimum price at OP1, which is lower than the equilibrium price OP0, it will have no effect on the market.

At the lower price, there will emerge excess demand (=GH), which will push the price back to the equilibrium price OP0, which is higher than the minimum price. To be meaningful, the floor price must be above the equilibrium price. Now suppose the government fixes the floor price at OP2, which is higher than the equilibrium price OP0. At this price the suppliers are willing to sell OQ2 quantity of the commodity while the quantity demanded is only OQ1. Thus, a surplus (or excess supply) of Q1Q2 (=KL) emerges (Wilkie 2007).

In this connection it can be said that Mr Massy was critical of the scheme adopted by the Australian government. He stated that the floor was fixed to drive up the prices artificially to an unsustainable level which ultimately brought the financial disaster in the Australian agriculture with a stockpile of 4.7 million bales and an industry debt of $2.7 billion (History of wool's reserve price n.d.). In the next segment the downsize of the price floor in the wool market will be described. Disadvantages of the floor price in any market as well as in the wool market The fixing of the floor price causes some disadvantages.

The fixing of the minimum price causes a surplus of the commodity. The producers receive a higher price (OP2) than the equilibrium price; the actual quantity bought and sold will fall to OQ1 i.e, lower than the equilibrium price. In this case some producers find it difficult to dispose of their product at the legally fixed minimum support price and they may flout the law and sell the goods at prices below the minimum price set by the government and in order to maintain this minimum price the government generally purchases the surplus stock and which remains unsold at the minimum price.

The disadvantages to the producers is that they must pay a premium and transaction cost and during volatile markets the premium can be high (Waller etal, 2008, p.1). In the Australian wool market the impact of the Reserve Price Scheme on the demand for wool is not clear because persistent price fluctuations destabilized the processors profits by the Reserve Price Scheme and hence tending to reduce the demand for wool. Until 1989, it was apparent that the Reserve Price Scheme reduced the volatility of the wool prices but evidences are there which states that the grower’s returns have been destabilized to a quite high level (Wool price stabilization n.d., p.35). Alternatives which the Australian government could have chosen instead of floor price The alternative which the government of Australia would have chosen instead of floor price could be an administered export quota system which is shown in the following diagram.

Instead of price floor if the government fixes an amount OQ2 to be produced by the producers at the price OP2 which is higher than the equilibrium price OP0. But in this case the consumers will be willing to pay OP1. Thus the government will pay the amount P1P2 to the producers and so the producers will get an incentive to produce and the new equilibrium will be reached at the point E2 with production level at OQ2 (Fontenay & Leung, n.d. p.5). The reserve price scheme in Australia was terminated in February 1991 due to failures in marketing schemes and maintaining the minimum price at a very high level.

The wool prices were very volatile at that time. In order to reduce the volatility of prices the producers of the wool found the future markets, auction markets, option markets and private sale as suitable options in order to stabilize the price fluctuation (Lubulwa et. al, 1997, p.8). Conclusion The study leads to the conclusion that Australian government imposed the floor price in 1980s which brought disaster in the agricultural market of Australia with an excess supply of 4.7 million bales and an industry debt of $2.7 billion. The floor price mechanism is shown in a demand supply framework.

After that analyzing the disadvantages of the floor pricing system an alternative way other than floor pricing have been suggested which is the quota system by which the producers and consumers will not be worse off and price stabilization will be generated at the same time. References CDC (2003), Australian Bureau of Statistics, CDC Home, retrieved on May 2, 2012 from: http://www.abs.gov.au/ausstats/abs@.nsf/Previousproducts/1301.0Feature%20Article172003?opendocument&tabname=Summary&prodno=1301.

0&issue=2003&num=&view= Fontenay. P.D. & S.Leung, (n.d.) Managing Commodity Price Fluctuations in Vietnam’s Coffee Industry retrieved on May 2, 2012 from: https://digitalcollections.anu.edu.au/bitstream/1885/40128/3/1902deFontenay.pdf History of wool's reserve price (n.d.), Weekly Times, retrieved on August 16, 2011 from: http://www.weeklytimesnow.com.au/article/2011/09/12/377321_wool.html Lubulwa et. al, (1997). Price risk management for Australian wool growers, retrieved on May 2, 2012 from: http://adl.brs.gov.

au/data/warehouse/pe_abarebrs99000685/PC11980.pdf Waller et. al, (2008). The Minimum Price Contract, retrieved on May 2, 2012 from: http://agecoext.tamu.edu/fileadmin/user_upload/Documents/Resources/Risk_Management/rm2-17.pdf Wool price stabilization (1990).Submission to the wool Review Committee, retrieved on May 2, 2012 from: http://adl.brs.gov.au/data/warehouse/pe_abarebrs99000207/sub_wrc90.4_wool.pdf Wilkie, S (2007). The Simple Economics of Price Floors, retrieved on May 2, 2012, 2011 from: http://www.colorado.edu/econ/seminars/wilkie.pdf