This economics assignment discusses the factors affecting lavender prices in Tasmania, including the expansion of demand from the essential oil industry and tourism sector. It also covers the price elasticity of demand for lavender and the short run cost of lavender farming.
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Running head: ECONOMICS ASSIGNMENT Economics Assignment Name of the Student Name of the University Course ID
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1ECONOMICS ASSIGNMENT Table of Contents Answer 1..........................................................................................................................................2 Factors causing change in lavender prices...................................................................................2 Answer 2..........................................................................................................................................4 Answer a: Price elasticity of demand for lavender......................................................................4 Answer b: Price elasticity of demand and revenue......................................................................5 Answer 3..........................................................................................................................................5 Answer a: Short run cost of lavender farming.............................................................................5 Answer b: Diminishing return of production...............................................................................6 References........................................................................................................................................7
2ECONOMICS ASSIGNMENT Answer 1 Factors causing change in lavender prices A competitive market is characterized by a market where considerably large number of sellers compete in the marketplace and produce a homogenous product. In such a market, following the presence of a large number of sellers each firm enjoys only a small share in the market. Share of each firm is so small that neither of the firms can influence price or output decision in the market. Equilibrium in the market thus determined from the demand and supply condition (Baumol and Blinder 2015). Price and output in the market corresponds to the market determined equilibrium point, Changes in demand and supply condition from external forces causes the demand and supply curve to resulting in a change in price and equilibrium quantity. Such changes in demand or supply shifts the demand or supply curve either upward or downward direction. Given that lavenders are sold in a perfectly competitive market, price in the market can only be changed in response to a change in either demand or supply. As stated in the article, in recent years the lavender industry in Tasmania is expanding due to expansion in demand. The main source of growing demand for lavender is increase in demand from tourist and expansion of essential oil industry (Sloman and Jones 2017). The figure below shows demand and supply of lavender industry to analyze the change in demand and associated change in equilibrium.
3ECONOMICS ASSIGNMENT Figure 1: Condition of lavender market (Source: as created by Author) Under the condition of competitive market, demand and supply of lavenders are given by DD and SS respectively. The joint forces of demand and supply results in equilibrium at E. Associated with the equilibrium, the equilibrium price and quantity of lavender in the market are P* and Q* respectively. Lavender is a vital input in essential oil industry. Globally, there is an increase in demand for essential oil which include the demand for lavender as well. The essential oil companies globally are looking to Tasmania as a producer of significant volume of lavender. This significantly pushes up demand for lavender. Another demand expansionary factor for lavender is tourism sector (abc.net.au 2018). The lavender tourism was put on an international stage four years back. The expansion in demand causes the lavender demand curve to shift rightward. The new demand curve for lavender is D1D1.The supply however cannot be increased in line with the demand given the cost constraint. The demand for lavender thus outstripped the
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4ECONOMICS ASSIGNMENT supply of lavender. The new equilibrium is achieved at the point E1.The higher demand causes an expansion of lavender market in terms of increase in both equilibrium price and quantity. The equilibrium price of lavender rises up from P* to P1. The equilibrium quantity in the market expanded from Q* to Q1. Answer 2 Answer a: Price elasticity of demand for lavender Several factors influence price elasticity of demand for a product. Following are some factors that influence elasticity of demand. Availability of substitutes The most important determinant of price elasticity is availability of number and type of substitutes. In case of availability of large number of substitutes, demand tends to be more elastic in nature. For a commodity having large number of available substitute, an increase in price of such a commodity causes a shift in demand to the close substitutes (Jain and Ohri 2015). This results in a large decline in demand. For lavender, there are many substitute essential oils are available in the market. Price elasticity of demand of lavender thus is price elastic. Nature of the commodity Nature of commodity determines the elasticity of demand. In case of necessary goods, demand tends to be less elastic as people are unable to make large adjustment to demand for a change in price (Maurice and Thomas 2015). For luxury goods on the other hand, demand tends to be more elastic as people adjust their demand largely for a corresponding change in price.
5ECONOMICS ASSIGNMENT Lavender is a necessary good. An increase in price of lavender thus have a large impact on its demand making demand more elastic. Number of uses Larger the variety of uses of a commodity, greater is the price elasticity of demand and vice-versa. If price of the product having various uses is high, then demand is small and the commodity is put into use of only important ones (Friedman 2017). Essential oils have variety of uses such as scent, therapeutic benefits, physical benefits and others. Following different uses of lavender oil, the demand is likely to be price elastic. Answer b: Price elasticity of demand and revenue The relative increase or decrease in revenue of a firm depends on the price elasticity of demand. For products having a price elastic demand, a small increase in revenue causes large decline in demand and vice versa (Chiang 2017). In this case, firms should adapt the strategy of lowering price to increase revenue because decline is price offsets by a larger volume of sales of the product. With inelastic demand on the other hand, an increase in price is associated with a relative smaller decline in demand. For product having price inelastic demand appropriate pricing strategy of firms is to increase price to increase revenue (Hill and Schiller 2015). Given the fact that lavender has a price elastic demand, an increase in price lower the revenue of lavender firms. This is because the larger increase in price causes a large decline in sales. In contrast, the firms enjoy a gain in revenue when there is a decline in lavender prices. Decline in prices cause a much larger increase in sales volume and is thus associated with a larger revenue. Answer 3 Answer a: Short run cost of lavender farming
6ECONOMICS ASSIGNMENT In the short run a business incur both fixed and variable costs. Fixed costs refer to the cost that are independent of level of production. Firms need to bear these cost even with zero output level. Variable costs on the other hand refers to those costs that depend on level of production. Variable cost varies with level of output. The fixed and variable cost together constitute short run cost. The major input cost for lavender farming include seeds, fertilizer, purchasing equipment, protection of plant and cost of labor (Cowell 2018). The equipment costs are fixed cost of farming. The basic equipment needed for lavender farming are Tractor, Disc, Bush hog, Drip irrigation system, Rototiller, String Trimer, Harvester, Distillation Unit, Dryer and other equipment. Irrespective of level of harvesting, firms need to purchase the equipment to carry out harvesting. These costs are thus belonging to part of fixed cost. Cost of seeds, fertilizer, labor cost and plant protection are variable cost of farming. These costs vary with level of harvesting. Higher the level of output larger is the cost. Answer b: Diminishing return of production In the production process, there is a certain point where employing additional factor input results in a relatively small increase in output. This is called diminishing return in the production process. The diminishing return generally occurs in the short run of production process. In the short run, at least one factor of production remains fixed. Now, if variable input increases continuously given one fixed input, the variable factor becomes less productive causing a decrease in marginal and average product (Cowen and Tabarrok 2015). This is because given fixed capital, an increase in number of workers means a decline in capital per workers. This causes a decline in marginal productivity. Now, if given the equipment the lavender firms increase variable input then they might experience diminishing returns in the production.
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