Business Article Analysis

Economics for Managers 551

Lamb prices offer relief for graziers

The article "Lamb prices offer relief for graziers" (Cranston 2010) discusses the rising retail price of Australian lamb and mutton as a result of reductions in the New Zealand lamb flock and the flow through of these price rises to Australian farmers.

Key microeconomic factors which can be extracted from an investigation of this article are:

1. A reduced supply of sheep meat due to a fall in the lamb flock and drought in New Zealand has resulted in rising prices for lamb and mutton in Australia.

2. Price rises for lamb have flowed through to suppliers in Australia, unlike rises for other food crops, and this has encouraged large graziers and agriculture investors to buy sheep stations and sheep grazing land.

3. A politician proposes a system to increase prices paid to farmers by introducing an arbitration commission to determine prices.

The lamb meat trade is dominated by New Zealand, which is the world's largest supplier of sheep meat; accounting for 75% of the market (Agricultural economies of Australia & New Zealand - sheep and beef 2006). New Zealand is a price maker because its production is a significant proportion of the world lamb market (McTaggart, Findlay, and Parkin 2010).

The Law of Supply shows that the price increase for lamb and mutton is a direct result of the decrease in supply, in this case due to a natural event. Figure 1 charts the movement in market equilibrium as a result of a decrease in the size of the lamb flock. At the original level of supply (S1), market equilibrium (E1) is established at equilibrium price (P1) and equilibrium quantity (Q1). A 2.5% drop in breeding ewe numbers and drought conditions decreases the supply of lamb, shifting the supply curve to the left (S2). To maintain equilibrium, market forces adjust the price upwards until a new equilibrium point (E2) is reached at a new equilibrium price (P2) and quantity (Q2). The death of 500,000 sheep in the recent blizzard will have the effect of further decreasing breeding ewes, reducing the available supply of lamb and shifting the supply curve further to the left again, resulting in further price rises until a new equilibrium point is reached.

Figure 1- Market price change due to decrease in supply

The retail demand for lamb in Australia has been shown by various studies to be elastic; the most recent figures showing the retail price elasticity of demand to be -1.54 (Griffith et al. 2001). Falling supplies of lamb and the resulting increases in price are signals to buyers and sellers to reallocate scarce resources to adjust to the new market conditions. Buyers will adjust by reducing their lamb consumption or substituting other sources of meat protein such as beef, chicken or pork (Griffith et al. 2001).

Whilst lamb producers have received farm gate increases in the price of lamb, growers of other food crops have not benefitted from the high prices resulting from a global shortage of supply (A growing opportunity for Australian lamb 2010). As the long run supply of lamb increases in response to high prices, the supply curve will shift to the right and reverse the shift in market equilibrium as described in Figure 2.

When this happens prices will fall as shown and inefficient lamb growers may suffer the same fate as their beef and dairy growing counterparts since they face the same perfectly elastic demand for their products.

Like any firm, a farm's goal is to maximise economic profit; so lamb growers will attempt to maximise the benefit of high retail prices. In the short run this is difficult; the supply of lamb will be relatively inelastic since it is hard for any firm (farm) to quickly increase the number of ewes necessary to breed lamb, or to quickly change other fixed factors of production such as the land required to graze sheep. In the long run, those enterprises with sufficient financial resources available to them are able increase the amount of grazing land they control and increase the size of their breeding ewe flocks. As indicated in the article, wealthy graziers and investors have made long run decisions and purchased sheep grazing land in order to expand their operations.

Figure 3 illustrates the average total cost