ECON1020: Prices And Markets - Milked Dry - Economic Analysis Assessment Answer

Price and Market Assignment

Assignment Task

Read the article Dairy farmers are being ‘milked dry’, but let’s remember the real cost of milk (The Conversation, 25/05/16) attached, about the animal welfare and environmental concerns associated with dairy farming in Australia.

Then use economic analysis to answer the following questions. In your answers, ensure that you use relevant economic theories, concepts and/or diagrams covered in this course. Note that general layman or journalistic discussions do not constitute sufficient economic analysis.

Question 1

The article calls for public policy initiatives to address animal welfare and environmental concerns associated with dairy farming in Australia. With reference to economic concepts covered in this course, explain why the government might want to intervene in the dairy market.

Question 2

A tax on dairy products is one public policy initiative that the government might consider. Perform appropriate economic analysis to explain how such a tax could be used to address the animal welfare and environmental concerns raised in the article. Discuss the pros and cons of using such a tax as a policy initiative.

Question 3

What other public policy initiatives can the government employ to address these concerns? Discuss the pros and cons of these.

Question 4

What can we as private individuals do to address these concerns in the absence of government intervention? Are such private solutions likely to be effective?

Solution: 1First, besides all the ethical concerns, there is a huge opportunity for the government to raise revenue through taxation. As much as the problem of dairy farming in Australia is believed to be an ethical problem, there is sufficient evidence to prove that an economic solution is the way out (Epstein & Buhovac, 2014). The main reasons why the government collects duty are to raise money to sustain itself, control foreign exchange and regulate industries. Punitive taxation targeting a particular product or group of products has indeed been shown to be an effective mechanism to control the consumption of such products (Moodie et al., 2013). The Danish Government is said to be considering this approach, meaning that it could be a valid economic solution to an ethical problem. This scenario is best described by the concept market failure.

Market failure is an economic situation where the pursuit of self-interests from a particular economic activity causes some other party to be worse off – a state referred to as inefficiency. The Coase theorem holds that in a market individuals exchange products as well as the rights to use them in a specific way and during a specific time. From this understanding, it is possible for a market to correct the failure within itself (Medema, 2014). Tax on negative externality solves the problem by transferring the full social cost of the product to the consumer. When the consumer has to pay more for a good, they will normally reduce their consumption to balance their purchasing power. Since consumers will tend to have fixed abilities to spend at a particular moment, transferring the cost of the externality to them will automatically reduce what they can purchase with the money available for spending.

Graph showing the inverse relationship between taxation and consumption

Production externality transfers the cost of production to a party other than the producer. It considers the wider cost of a good to the society such as its environmental impact. It is perceived that negative externality can effectively cover the social costs of a good such as its environmental impact. However, the criticism against negative externality is the difficulty in quantifying the social cost of a good in order to apply a matching charge on to say, the consumers (Mariappanadar, 2012). For instance, the actual cost of pollution by dairy cows cannot be financially quantified.

Solution: 2

When the production of a good attracts negative externalities, an activity’s private cost is normally lower than its social cost. The overall impact is an inefficient outcome which is likely to incentivize overproduction of the good. Indeed, taxation is thought to be an effective public policy initiative capable of addressing various social issues (Byrnes et al., 2013). Market-based policies are initiatives that utilize various economic variables such as price to address market failure of externalities. Environmental policy-making, market-based instruments are seen as a practical solution to covering the environmental costs of goods.

Corrective tax policies motivate stakeholders in the economy to reduce the production of goods or services associated with negative externalities. Taxation as a public policy initiative work by increasing the production cost of the targeted good, hence, discouraging producers from producing more output. Following economics of demand and supply, the situation eventually limits the consumption of the targeted good.

From the graph it can be deduced that output from production tends toward the socially optimal level upon application of the tax. The problem with taxation as a public policy initiative is usually the lack of a formal method to quantify the negative externality associated with a good. The corrective tax (Pigovian tax) should ideally reflect the cost of the externality because its primary purpose is to address such a cost. An advantage of tax is its ability to instantly create the desired shift in production level. Application of a tax policy instantly raises production costs, which immediately incentivize producers to lower output. Through such a policy, the government is also able to raise its revenue collection. Disadvantages of tax are the difficulty in quantifying the social cost and the pressure from corporate players that usually follows such policies. Corporate stakeholders argue that such policies substantially affect the profitability of the affected industries and may push them out of business.

Solution: 3

• Subsidies

Subsidies are believed to be able to address welfare issues and negative externalities associated with a good. When implementing a subsidy policy, the government would bear the costs of production in part to incentivize the production of a certain good. Such a good is usually an alternative to the good producing the negative externality. In the case of the Australian dairy industry, subsidies can be provided to soy milk production. Soy farmers can acquire seeds or other input at shared costs with the government to encourage its production and replacement of cow milk.

However, subsidies have many deficiencies. First, the alternative good may not be a good match for the one with negative externality. Hence, it may not shift downwardly the production of the harmful good to the socially optimal level. Secondly, the government cannot have as much money to compete with the private sector’s counter-strategies of subsidy policies. Therefore, subsidies may not be a sustainable approach. Subsidies also destabilize

the economic environment of the affected good usually with unpredictable consequences. All considered, subsidies can serve as alternatives to tax, but are not likely to be as efficient.

• Pollution permits

Pollution permits are also market-based instruments that can be used to limit negative externality of a good. Producers are issued with licenses to pollute only to a certain quantified amount. If they pollute less, they can sell remaining allocations to other producers. Theoretically, it is a very good model for monitoring and controlling pollution caused by the production of certain goods. However, in reality, the model faces the challenge of verifying the actual amount of pollution that a producer creates. This may reduce the effectiveness of the policy. The economic effects of pollution permits may also not be justified – producers may incur higher costs by controlling their pollution and may thus resort to cheating.

• Regulation

The regulation defines goals that the policy aims at and expects stakeholders to work towards the goals in their own capacities. It is a passive policy on addressing pollution and welfare issues. Depending on the economic environment and other factors such as societal objectives of the affected community, regulation may be effective or it may not.

Solution: 4

Private solutions

Private individuals are likely to achieve significant impact in addressing the ethical issues raised. In fact, without the integration of the support of private citizens to the other alternatives, they may not work. First, the premise that holds that taxation can reduce consumption of a good by raising its cost is challengeable. For some products, it may require an abnormal rise in cost to effectively prevent consumers from accessing the good. Consumers can always adjust to minor changes in the cost of their favorite foods (Majumder, Ray & Sinha, 2016). But abnormally raising the cost of a good through taxation may make little or no economic sense as it may drive producers out of business. However, if private individuals realize and accept the need to address these concerns, they can cut their consumption of such goods and hence their prices.

Besides changing consumer behavior, private citizens can put pressure on firms to consider the social impacts of their production. The results of such actions can only be realized collectively. However, each private citizen must play their individual role. For instance, people can avoid goods from producers with a negative reputation regarding their environmental and welfare stands. Such action by private citizens cannot be easily subjected to corporate manipulation and may therefore be a very effective approach to addressing the issues.

Considering all options available to addressing the issues, private citizens play a pivotal role. Without the inclusion of the participation from individuals most of these policies may not be effective. For market-based instruments, taxation seems to be the ultimate tool for addressing negative externalities of production.