Wool was an important industry for
Australia as it was the number one industry that helped build Australia in the
late 1840’s itself. The Australian Merino was one of the world’s finest wool
growers. Nevertheless, the industry had a big collapse in the 1980’s also known
as one of the biggest business disasters that cost over 10 million dollars of a
debt of 3 million dollars that Australian wool growers were lumbered will along
with other costs that hit Australia. Many wool growers suffered from the wool
collapse. Hence, the Reserve Price Scheme was introduced as a guarantee to
Australian wool growers a minimum price for their wool. It was introduced to
protect the wool industry as a means of nation building besides bringing stability
to the fluctuating wool prices. In 1991 however, the scheme failed causing a
collapse in the wool market (Wool Bale Out, 2011, http://www.abc.net.au/landline/content/2010/s3287468.htm).
The reserve price scheme is to set a
minimum price for wool set above the equilibrium price. In short, a floor price
was set. Price floor is a regulation enforced by the government that makes it
prohibited to charge below the specified price which is the price floor. A
price floor needs to be set above the market equilibrium to be effective as
there will be no effect if the price floor was set below the price equilibrium.
When the price floor is above the equilibrium, it will result in a surplus
because the wool supply exceeds the wool demand.
The remaining part which is A + C
is the potential loss from consumer searching for wool. The supply of wool
fails to meet the demand of wool in the short period of time (short run).
Based on the graph above, it can be
seen that the consumer surplus at equilibrium price, Pe was C + D + F. After
the floor price, Pf, the consumer surplus was F only. This is because when
price increases from Pe to Pf, the quantity demanded reduces from Qe to Qd
which results in a loss in surplus.
The producer surplus at equilibrium
price, Pe was A + B + E. After the floor price, Pf, the producer surplus was E
only. So, there was a loss in producer surplus as well because the wool growers
were not efficient as they did not take into consideration the demand of
consumers.
The deadweight loss is the total
loss in surplus due to inefficiency. In this case the deadweight loss is D + B.
This is because the total surplus is not at its maximum and there is an
underproduction of wool supply.
Diagram
1: Wool production in the short run
The implementation of floor price, Pf, by the government through its
Reserve Price Scheme as mentioned above results in a surplus. The reason why
there is a collapse of this scheme is instead of maintaining a conservative
price floor; the scheme eventually made this a price extraction which in a way
also it failed as there was deadweight loss (inefficiency of production).
The price elasticity of demand for wool changes from
inelastic to elastic over time. In the long run, the demand for wool is price
elastic as shown in Diagram 2 as there are now substitutes available. Wool
prices halved by the late 50’s as the wool industry had to face new competitor
i.e. synthetic fibres such as nylon and polyester (Wool Bale Out 2011). Consumers
can now choose to purchase synthetic fibres rather than wool itself should the
price continue to rise. Also, despite the drop in floor price to 700 cents a
kilo, there is still stockpiling of wool, indicating that demand for wool by
consumers did not increase much. The reason so is because demand hardly
changes.
On the other hand, the price elasticity of supply is
inelastic due to the producers having to either work its labour force overtime
or hire additional workers to increase production. In the long run, supply
becomes price inelastic as shown in Diagram 2 because as time passes, producers
can now increase their supply. This is proven through stockpiling when the
price increases from Pe to Pf thus, supply is more inelastic.
In terms of consumers and producers surplus, in the
long run, both remain the same as mentioned in part (a). The only difference
would be the magnitude of loss because the price elasticity’s of demand and
supply had changed over time. For the same reason, the magnitude of deadweight
loss differs from that mentioned in part (a). This is because there was no
disaster like this before so comparison is not needed. Since deadweight loss
still exists in the long run, it can be concluded that the Reserve Price Scheme
is not the right solution.
Diagram
2: Wool production in the long run
In the long run, there would be a
rapid increase in supply of wool as producers increase production. This causes
the supply curve to shift from S to S1 as shown in Diagram 3. As
for demand, it declines as there is now substitutes available i.e. nylon and
polyester for consumers to choose from. Thus, the demand curve shifts to the
left from D to D1 as shown in Diagram 3. The increase in supply
together with the fall in demand causes the price to fall from P1 to P2 and quantity to rise from Q1 to Q2.
As a result, total revenue of wool producers decreases from the red area to the
blue area, indicating that wool growers are making a loss from its production. This
price ceiling is no longer effective due to the loss for wool growers.
Diagram
3: Wool producer’s total revenue
The collapse of the wool industry
would have impacted the clothes industry. Woollen clothes would decrease in
production and the supply for wool’s close substitutes would increase instead.
Some examples of wool’s close substitutes would be nylon, polyester and
synthetic fibre. Besides that, the food industry would also be affected. With
the collapse of the wool industry, it is highly likely that the production of
wool will decrease therefore resulting in less sheep being killed. When less
sheep are killed, there is an increase in supply for lamb meat.
The Australian government’s
intention of helping the wool industry with the implementation of the Reserve
Price Scheme only worsened the situation. It did not benefit the producers as expected
and instead brought great suffering to both producers and consumers of the
market whether in the short run or long run. Furthermore, the Reserve Price
Scheme was inefficient due to deadweight loss and it also left a permanent scar
on the market even after it was scrapped. The government could have instead
tried subsidising the producers or providing incentives as a form of assistance
for farmers. As a conclusion, the Reserve Price Scheme implemented by the
government did not have a good impact on the wool industry.
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