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MICROECONOMICS ASSIGNMENT

Summer Semester 2016

Due date: Monday, 9 January 2017 (by 5pm AEST)


Instructions:
I.
This assessment exercise will account for 20% of your final grade in the subject.
II.
There are three questions. Answer all questions.
III.
Illustrate with diagrams where appropriate.

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Question 1 (8 marks)
Read Attachment 1.
Answer the following questions. Use diagrams where appropriate. [Assume that the Australian grape and wine
industries are perfectly competitive markets]:
Use demand and supply models to illustrate and explain the following: [Use the demand and supply model for a
domestic market]:
a.

Discuss any demand-side and/or supply-side factors that can explain the recent change in the price of
grapes. (2 marks)

b.

Illustrate and explain the impact these changes have had on the price and quantity traded of grapes?
(3 marks)

c.

What impact has these changes in the grape market had on the price and quantity traded of domestic
wine? (3 marks)

Question 2 (5 marks)
Read Attachment 2.
a. Use the demand supply model to explain how changes in demand could cause seasonal variation in the
equilibrium price of oil. (2 marks)
b. Use the demand supply model to show how the extent of seasonal variation in oil prices can depend
on the elasticity of supply. Why would ' ....a shortage of refining and storage capacity' cause greater
seasonal variation in oil prices? (3 marks)

Question 3 (7 marks)
Read Attachment 3.
a.

In attachment 3 two possible explanations for the higher price of pork are proposed. Suppose you
have data on the market equilibrium price and the total quantity traded of pork over time. Using this
data would it be possible to distinguish between the two possible explanations to say which is
correct? (3 marks)

b.

Suppose that the possible explanations for the higher price of pork were a higher price of grain or
higher incomes of consumers in China. Again using just data on the market equilibrium price and total
quantity traded of pork over time, would it be possible to distinguish between these two possible
explanations to say which is correct? (4 marks)

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Attachment 1
A tax break led to vineyards sprouting everywhere. Now Australia --mon Dieu!--is faced with its own wine
lake.
(Source: www.forbes.com/global/2006/0724/051_print.html; accessed 17 July 2006)
Glen Arnold has been growing grapes in South Australia's Riverland wine region for more than 30 years and says
times have never been so tough. This past season a third of his fruit shrivelled on the vine because Arnold
couldn't find a buyer, not even at a quarter of the usual price. To stunt the growth of the next crop, he may
prune his 45 acres of vines severely and limit how much water they get. "I feel devastated," he says. "It's very
hard to stay positive."
These should be the best of times for Australia's wine industry. The country's finest wines are snatching trophies
away from the French in international competitions. And wine exports have swelled from $305 million in 1995
to $2.1 billion last year, the fourth-highest in the world.
But despite the awards and the export dollars, many of Australia's 2,000 wineries and 8,000 grape growers are
facing a French-like crisis: There are far too many vineyards producing far too many grapes, and that's killing
profits. Growers in the main wine regions--the Riverina in New South Wales, and Riverland--are being offered as
little as $75 a ton, well below the $225 it costs them to produce the fruit. This reality became so frustrating for
one grower that he plotted to blow up a winery that was offering him a fraction of what he usually got for his
grapes, according to a court hearing in Melbourne last month. So--in emergency meetings--grower associations
are urging members to uproot or mothball their vines this winter. In just the Murray Valley, a region in Victoria
that typically supplies a quarter of Aussie wine grapes, some 50,000 tons were left to rot on the vine during the
2006 harvest, according to a trade association.
The problems don't end in the vineyard. Using those cheap grapes, wineries are producing a huge surplus, which
is shredding prices for bulk and other low-end wine. In fact, the surplus is large enough to serve every man,
woman and child in the world a glass on the house. Some wine outfits are taking big writedowns on their
inventories. McGuigan Simeon Wines says it might post a loss for fiscal 2006; its market cap has fallen by $300
million in 18 months. Evans & Tate lost $37.5 million in fiscal 2005, and it's valued at a paltry $4.5 million, down
from $53 million five years ago.
As often happens in any country when an industry runs into trouble, the grape growers have pleaded with the
government for help. But what's surprising is that, in Australia's case, officials have turned them down. The
industry wanted a $45 million bailout that would pay growers not to pick some 300,000 tons of grapes in each
of the next two years. But the government has been adamant that instead of propping up failing vineyards, it
should let market forces decide which ones survive. "Although it does sound mercenary, it's not in our interest
to see that everyone survives," says Stephen Strachan, the chief executive of the Winemakers' Federation of
Australia.
There's irony in the plea for government help today: The industry can trace its problems to 1993, when
winemakers wanted measures to boost the supply of grapes because export demand was growing. Canberra-more eager to intervene than it is today--obliged. It rewrote the depreciation rules so growers could write off
the cost of buying and planting vines over just four years, rather than over the lifetime of the vines as with other

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agricultural assets. What's more, the growers could now take the deductions from the moment the vines were
planted, instead of waiting until the first grapes were sold, giving vineyard owners a lucrative shelter for their
other income.
It took a few years for growers to gear up, but by the late 1990s vineyards were claiming bigger stretches of the
Australian landscape--in some cases with tax-savvy but largely unskilled owners at the helm. In just three years-1997--99--growers planted some 100,000 additional acres, a 40% increase over the 250,000 acres already
producing grapes. It had taken 30 years to plant the previous 100,000 acres. By 2000 a grape glut and a wine
lake were inevitable with a good harvest.
To be sure, other factors contributed to the frenzy of plantings. In the 1990s, after years of trying to gain
acceptance overseas, Australian wines suddenly became the flavour of the month. Exports jumped 36% in 1996.
Then the Australian dollar began a long decline, going from 80 U.S. cents in 1996 to 50 cents five years later,
which helped export growth--and the demand for grapes--stay high. Grape growers could make extraordinary
returns--sometimes surpassing $1,500 a ton for their fruit. With this kind of money to be made, why not start a
vineyard?
Even before the deluge of grapes hit the market, there were signs that the party wouldn't last. Chilean,
Argentinean and South African vintages were muscling their way onto wine-shop shelves in the U.S. and U.K.
Then the Aussie dollar reversed its slide: It's now back to 75 U.S. cents. Export growth suddenly plunged from
28% in 2002 to 6% the next year. For the 12 months through May 2006 exports rose just 1%, according to the
Australian Wine & Brandy Corp. And the wine is getting cheaper, as wine lovers can attest: an average of just
$2.88 a litre versus $3.59 in 2002. "Once it became evident how many grapes were being planted, it became
obvious that we were going to have a challenge on our hands," says Strachan. "For some it's become a crisis."
Australia finally scrapped the tax break in 2004, putting vineyards back on the same footing as other forms of
horticulture. "Unfortunately, that tax break was left on for three or four years too long," says Arnold, the
Riverland grower. The move, according to Australian Senate documents, came "in response to 'concerns that
accelerated depreciation--which drove considerable expansion of the industry over the past decade--could lead
to oversupply.'" Could, and did, meaning that growers without long supply contracts with major wineries or
beverage companies might be unable to sell next year's harvest, or the year's after that.
For the Australian wine industry, it may all be for the best. The glut of cheap grapes and cheap wine, coupled
with the stiffer competition overseas for the mass end of the market, is sending growers and winemakers a
message: Move upscale. Indeed, many in the business prefer a smaller, nimbler and more profitable industry
based on internationally recognized brands. That would mean more higher-margin premium exports and less of
the cheap stuff.
The Party's over
Australia is facing tougher competition overseas as the year-on-year growth in the value of its wine exports has
declined sharply in recent years.

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Attachment 2
Moreover, the price of oil usually falls in the autumn, after the summer surge in petrol consumption has abated
but before winter brings higher demand for heating oil. According to Sabine Schels, a commodity strategist at
Merrill Lynch, seasonal swings in fuel prices are becoming more pronounced, thanks to a shortage of refining
and storage capacity. At times of peak demand, she argues, the petrol price must rise high enough to prompt
the reopening of old and inefficient refineries that would not normally be profitable. Those refineries, in turn,
use up a lot more oil, pushing up its price too.
The heat is off, The Economist, June 10 2006

Attachment 3
While many China-watchers fret about the consequences of a collapse of Chinas stock-market, Wen Jai-bao,
the prime minister, seems more worried about the risk of social unrest as a result of the sky-rocketing price of
pork. A 50% rise in the average nation-wide price over the past year is causing squeals of alarm
Economists are scratching their heads to explain the price jump. Some blame it on blue-ear, a contagious disease
which may have killed 18,000, or 20m pigs, depending on whom you believe. Others say the main cause is the
surge in global grain prices, which have increased the cost of feed for pigs
Year of the golden pig, The Economist, June 9 2007, page 30.

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