Impact of Price Shock on Fonterra

Running head: IMPACT OF PRICE SHOCK ON FONTERRA
Impact of Price Shock on Fonterra
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IMPACT OF PRICE SHOCK ON FONTERRA1
Table of Contents
Introduction......................................................................................................................................2
Task 1: Microeconomic analysis.....................................................................................................2
1. Rise in price of milk in New Zealand......................................................................................2
2. Brief on dairy industry and its condition between 2013 and 2014..........................................3
3. Response of individual farmers to price change and cause of over supply.............................4
4. Impact of increase in world dairy price...................................................................................5
Task 2: Macroeconomic analysis.....................................................................................................5
1. Circular flow of income...........................................................................................................5
2. Government expenditure.........................................................................................................6
3. Impact of surge in dairy exports on price level and aggregate demand of New Zealand........7
Conclusion.......................................................................................................................................8
Reference.........................................................................................................................................9

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Introduction
Fonterra is the largest company in New Zealand in terms of revenue. The company
operates in diary industry and is the largest exporter of diary in the world with around 30% share
of world’s dairy exports. Fonterra is of cooperative structure and is owned by nearly 10500
farmers (Coker et al., 2018). This report studies the response of New Zealand dairy industry to
the large price shocks that occurred between 2012 and 2018. With an objective to study the dairy
industry of New Zealand, the case of Fonterra has been considered in the report. The study is
categorized into two parts, one is microeconomic analysis and the other is macroeconomic
analysis. Under microeconomic analysis, the report discusses causes of rise in price in the
industry and along with it focuses on change in the dairy industry during 2012 to 2014. The
discussion includes the impact of price change on dairy farmers, domestic demand and exports of
New Zealand. The income, measurement of GDP and export of New Zealand is the core concern
under macroeconomic analysis in the report. Therefore, the report considering both the world
and domestic market of dairy studies the impact of price shock on the dairy industry in New
Zealand focusing Fonterra.
Task 1: Microeconomic analysis
1. Rise in price of milk in New Zealand
The given figure shows the farmgate prices of dairy paid by Fonterra. It is evident from
the figure that Fonterra had to pay increased price for milk during the period of October 2012
and February 2014 (Harvey, 2018). It is due to the sudden rise in price of milk in the dairy
industry. The surge in price of milk is due to the increased demand for milk in China (Cameron,
2019). China exports a large amount of whole milk powder in order to produce infant milk based
food, ice cream and other dairy products such that the high demand for the above mentioned
products can be met in the country. This increased the demand milk powder produced in New
Zealand. Responding to the increased demand from China, New Zealand exported whole milk
powder worth 744, 000 tonnes to China between 2013 and 2014. This increase in demand for the
said product initiated in 2012. As per theory of demand, it is known that with rise in demand the
price for products increases given the amount of supply (Howden, McCarthy & Hyde, 2016).
The rise in price in the dairy industry in New Zealand is a similar case. The graphical illustration
of surge in milk price due to rise in its demand is shown in figure 1 given below.

IMPACT OF PRICE SHOCK ON FONTERRA3
Figure 1: Rise in milk price due to increase in its demand
Source: (Created by the Author)
In figure 1, due to rise in milk demand in China the market demand curve shifted outward
in New Zealand. This happens because China imports milk from New Zealand (Zhang et al.,
2017). Therefore, the increased demand given the amount of supply the price of milk in New
Zealand’s dairy industry increased from P to P*.
2. Brief on dairy industry and its condition between 2013 and 2014
New Zealand’s dairy industry is significantly large. It is the largest industry of the
country. There are huge number of farmers involved in dairy farming in the country. However,
for dairy farming there is requirement for specific inputs (Ilyas et al., 2019). The basic inputs that
are required to become a dairy farmer are the food for the cows, land and cows. However, the
becoming a milk processor is a comparatively difficult venture and it requires several inputs and
they are energy inputs such as electricity and heating fuels for the thermal processing plant (Wild
et al., 2019). The major inputs are raw milk, refrigerant, containers and any services required to
maintain the processing plant.
New Zealand’s dairy industry is broadly depended on China. Data show that New
Zealand is exporting milk to China since 2008 after free trade agreement signed between the
concerned two countries (Gooch, Hoskin & Law, 2017). The volume of milk exported to China