Introduction to Microeconomics - Essay Example

An Economic Analysis of UK Milk Industry The UK is the 10th largest milk producer in the world and the 3rd largest in Europe. Dairy Farming in the UK is a semi-intensive livestock industry which accounts for around 19% of UK agricultural production by value and is the single largest agricultural sector at £2.7 billion. (DEFRA, 2006a)Yet in spite of the seemingly lucrative prospect from the industry, many dairy producers/farmers are now leaving the industry. The average rate of exit has increased from 5% (1996-2000) to 7% in recent years (2001-2005).

The reason for this is the very low farm gate price of milk which is lower than production costs. Figure 1 shows the pattern of farm gate prices: Source: DEFRA cited by (Everington, 2006)In 2004-2005, UK still remained as the lowest farm gate priced dairy producer for the 7th consecutive year. Comparing prices, the UK has a 37% gap as compared to Italy who receive a milk price of 35.8 euros/100kg compared to UK at 25.9. The reasons that were deemed to have caused this low farm gate price are the industries poor selling systems, bad forward contracts, excess profits up the dairy food chain, too much spring milk and currency effect or the £ / Euro relationship.

However, even with the loss of farmers, the UK milk and dairy industry has grown gradually but steadily since 1998 and the total value of the market increased by 2.9% to £7.23bn in 2002 (DEFRA, 2006b).Why then in spite of the loss of producers, is the industry thriving? A September 2005 report by the Milk Development Council revealed that there was a discrepancy between the profits received by sectors of the supply chain. That is, some of them are earning excessive profits at the expense of the others.

The report showed that supermarket, retail and processor gross margins on dairy products have increased over the past 10 years. Farm gate prices were also higher on average during 2004 as compared to 2003 but this increase was minimal as can be seen by the figure below: Dairy Farmer Price PplRetail PricePplSupermarketOperating Costs &Margin %ProcessorOperating Costs & Margin %199524.9442.00339200016.9339.001847200318.146.62846200418.547.52846200518.450.13147 Source: (MDC, 2005)The problem now becomes apparent.

The farm gate prices being low, it is expected that local and international sales of the product would be high. This is because low production costs usually mean low sales price. However, because of the high margin imposed on the product by businessmen, the products total production costs becomes much larger leading to higher sales price. This translates to lower sales volume because there is an inverse relationship between price and demand. This unfair share of profits and the low farm gate are what caused Scottish dairy farmers to conduct a blockade over the countrys major milk tanker depots in 2003.

Sean Rickard, which used to be the chief economist for the National Farmer’s Union, recommended that farmers should join together into co-operatives to process milk if they want a greater share of profits. There is wisdom in Rickard’s comment since farmer cooperatives, much in the same way as collective bargaining, can provide competition to investor-owned businesses and to get a “fair price” for farmers like lower price for fertilizer or a higher price for a milk product. This is what farmers in other countries such as the United States have been doing.

However, the American experience has shown that farm cooperatives do not necessarily succeed as they tend to continue to offer unprofitable services, accept mediocre financial returns, return too much money to members, do not adjust to new economic realities and do not prepare for economic reversal. However, with sound management, farm cooperatives can still succeed. (Ludwig, 2006).Reference:Department for Environment, Food and Rural Affairs (2006a). UK Dairy Industry. Retrieved from www.defra.gov.ukDepartment for Environment, Food and Rural Affairs (2006b).

Frequently Asked Questions. Retrieved from www.defra.gov.ukEverington, Nick (2006) The Dairy Industry Today. Royal Association of British Dairy Farmers (RABDF). Retrieved Dec.10, 2006 from www.rabdf.co.ukLudwig, Robert (2006). Farmer Cooperatives Real Businesses?. The Hale Group. Retrieved Dec. 10, 2006 from www.halegroup.comMilk Development Council (2005). “Dairy Supply Chain Margins” Report, September 2005. Retrieved Dec. 10, 2006 fro www.mdc.gov.uk