Economics Assignment: Analysis of Lavender Market and Production Costs

This economics assignment delves into the intricacies of the lavender market, examining the factors that cause price fluctuations within a competitive market structure. It explores the impact of increasing demand from tourism and the essential oil industry on lavender prices, illustrating this with a supply and demand model. The assignment then investigates the price elasticity of demand for lavender, considering the availability of substitutes, the nature of the commodity, and its various uses. It further analyzes how price elasticity affects revenue for lavender firms. The final section discusses the short-run costs associated with lavender farming, including fixed and variable costs, and explains the concept of diminishing returns in production, providing a comprehensive analysis of the economic principles at play in the lavender market.

Running head: ECONOMICS ASSIGNMENT
Economics Assignment
Name of the Student
Name of the University
Course ID

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

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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.

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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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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.

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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

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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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References
abc.net.au., 2018. High Tasmanian lavender production costs stifle growth. [online] ABC News.
Available at: https://www.abc.net.au/news/2018-01-07/tasmanian-lavender-industry-facing-
growth-challenges/9308346 [Accessed 23 Nov. 2018].
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Nelson
Education.
Chiang, E.P., 2017. Microeconomics: Principles for a Changing World. worth publishers
Macmillan Learning.
Cowell, F., 2018. Microeconomics: principles and analysis. Oxford University Press.
Cowen, T. and Tabarrok, A., 2015. Modern principles of microeconomics. Macmillan
International Higher Education.
Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University Press.
Hill, C. and Schiller, B., 2015. The Micro Economy Today. McGraw-Hill Higher Education.
Jain, T.R. and Ohri, V.K., 2015. Principal of Microeconomics. FK Publications.
Maurice, S.C. and Thomas, C., 2015. Managerial Economics. McGraw-Hill Higher Education.
Sloman, J. and Jones, E., 2017. Essential Economics for Business. Pearson.