Banana Economics Assignment

The article ÐŽ§Pain at checkout as WA bananas go eastЎЁ by Regina Titelius and Jennifer Eliot states that in the wake of cyclone LarryÐŽ¦s unforgiving wrath on Queensland, banana prices have soared throughout the nation over the last month and are expected to rise even more following WAÐŽ¦s wholesaler Mercer Mooney declared that Carnarvon bananas would be shipped east. Following cyclone LarryÐŽ¦s destruction on Queensland, it has wiped out about 80 per cent of AustraliaÐŽ¦s bananas destroying fruit worth $300 million, thus leaving Australia to possibly face a 3 year shortage as QueenslandÐŽ¦s banana industry slowly recovers from the damages. However, to really see the full impact of the cyclone on banana prices and the effect on societyÐŽ¦s welfare, the economic aspects of demand and supply, elasticity, consumer and producer surplus, total surplus and the governmentÐŽ¦s subsidy for banana farmers will be analysed in this report.

The economic aspects of supply and demand the most basic fundamental concepts in economics used by economists to analyse competitive markets. The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. The law of demand claims that, ceteris paribus, the quantity demanded of a good falls when the price of the good rises. The quantity supplied of any good or service is the amount that sellers are willing and able to see. The law of supply states that, ceteris paribus, the quantity supplied of a good rises when the price of the good rises (Gans, King and Mankiw, 2005).

QueenslandÐŽ¦s ЎҐregion [that] produces over 90 per cent of AustraliaÐŽ¦s banana crop, has been wiped out for this yearÐŽ¦ (Koch, Wahlquist, 2006), and as a result of the decrease in the number of banana suppliers, prices immediately began to soar dramatically throughout the nation. Australian Banana Growers Council chief executive Tony Heidrich had already suggested that banana prices were ЎҐcertainly going to go up and go up dramaticallyÐŽ¦ (Koch, Wahlquist, 2006). As a result, within two days of the cyclone, banana prices at Coles and Woolworths rose to $4.98/kg from $3.98/kg on Monday and are expected to continue to rise. With cyclone Larry destroying the many banana farms in Queensland, the supply curve shifted upwards from S0 to S1. In other words, as a result in the reduction of the determinant of banana sellers in the market due to the cyclone, the amount of bananas that firms are able to produce and sell at any given price decreases. The supply curve shifts to the left because, at every price, the total amount that firms are willing and able to sell is reduced (Gans et al, 2005, p.74). From Figure 1 it can be seen that as the quantity of bananas demanded decreases from Q0 to Q1, the price of bananas rises from P0 to P1 (Gans et al, 2005, figure 4.11). Hence it can be seen that the overall effect of the cyclone causes the number of banana suppliers to decrease which ultimately causes the equilibrium price of bananas to rise and equilibrium quantity to fall.

Figure 1 Shift of supply curve as a result from cyclone (Source: Gans, King and Mankiw, 2005 figure 4.11 pg 75)

However, the amount by which the price of bananas increases and quantity decreases depends on the economic concept of elasticity. Elasticity is a measure of how the responsiveness of quantity demanded or quantity supplied changes in response to another variable (Gans et al, 2005, p.84).

If the supply of bananas in the banana industry was relatively inelastic with an elasticity of less than 1, then quantity supplied would move proportionally less than the price and hence supply is said to be inelastic (Gans et al, 2005, p.100). So a decrease in supply would cause the price of bananas to rise more than the quantity of bananas to fall. Figure 2 illustrates the shift of the supply curve when supply is relatively inelastic with P0 „_ P1 increasing more than the decrease from Q0 „_ Q1.

Figure 2 Shift of inelastic supply curve (Source: Gans et al, 2005 figure 5.9 pg 98)

However, if the supply of the banana industry was relatively elastic with the elasticity greater than 1, then quantity supplied moves proportionally more than the price and hence supply is said to be elastic (Gans et al, 2005, p.100). Figure 3 shows that a decrease in supply would cause the decrease in quantity of bananas (Q0 „_ Q1) to outweigh the increase in price of bananas (P0 „_ P1).

Figure 3 Shift of elastic supply curve (Source: Gans et al, 2005 figure 5.9 pg 98)

Following the wake of Larry destroying all the banana crops in Queensland and hence causing the supply curve to shift leftwards, a decrease in supply not only affects price and quantity, but it also affects consumer and producer surpluses and the total surplus of the economy. Consumer surplus measures the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it where consumer surplus is the area below the demand curve and above the market price (Gans et al, 2005, p.127). Figure 4a and 4b illustrates the before and after changes in consumer surplus as a result of the cyclone in Queensland.

Figure 4a Consumer surplus before cyclone Figure 4b Consumer surplus after cyclone

(Source: Gans et al, 2005 figure 7.3 pg 131) (Source: Gans et al, 2005 figure 7.3 pg 131)

Figure 4b shows that as a result of a decrease in banana suppliers in the market, the supply curve shifts upwards causing the equilibrium price and equilibrium quantity of bananas to decrease. Figure 4b also depicts that at a higher market price for bananas, consumer surplus will be reduced. The area of A+B+C+D in figure 4a marks the original consumer surplus before the cyclone hit Queensland whereas in figure 4b the area of consumer surplus after the cyclone occurred is now marked only