The Economic Environment Of Business

THE ECONOMIC ENVIRONMENT OF BUSINESS:

1. INTRODUCTION:

This report focuses on milk and dairy products in the UK and the market trends in the recent past, we will focus on liquid milk, cheese, yogurt, butter and cream which are products associated with milk. The sales in the recent past for this products has continued to grow despite the relative mature nature of this market, keynote estimated that in 2005 there was a rise in the retail sales of this products by 3.8% using 2004 as the base year, in 2005 the total UK revenue was worth 8.16 billion pounds. [1]

Milk products are generally purchased by all households, however liquid milk accounts for the largest share of this market. On the other hand cheese faces strong competition from other complimentary goods. Health agendas such as the need to consume omega fats, cholesterol lowering products and probiotics in 2005 and 2006 have led to a growth in the market of milk products.

Other market drivers for these milk products are the increased variety of products including flavoured milk, and also the increased advertising efforts by companies. Suppliers and processors of milk products have adopted measures that aid them to act on interest of

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consumers.

However the market for milk products faced difficulties in the year 2001 to 2002 due to very low farm gate prices and the foot and mouth diseases that affected UK herds, UK milk quotas and the low farm gates has led to the prices being lower than the cost of production placing the farmers under great pressure and also extend on their limits. [2]

2. MAIN COMPANIES INVOLVED IN PRODUCTION OF MILK PRODUCTS AND THEIR MARKET SHARES

Some of the major companies in the UK involved in the production of milk and milk products include; Robert Wiseman Dairies, Unilever Best foods UK Ltd, The Yeo Valley Organic Company Ltd, The Kerry gold Company, Kraft Foods UK Ltd, New Zealand Milk Product Ltd, Dairy Crest Group and the Muller Dairy company. [3]

Milk and milk products producing firms assume an oligopoly market structure where there are restrictions or barriers to entry, these barriers to entry are associated with health issues and also the prevention of unhealthy competition, market prices are causing these firms to shut down and also the farmers are under pressure in the production of milk to these prices.

Market structure that exists:

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The market structure that exists in this industry is an oligopoly structure, an oligopoly market structure the market is usually dominated by a few firms, this type of market structure falls between a perfect competition and a pure monopoly. This type of market there are times when there is high competition while at other times the firms in an oligopoly may collude by fixing prices and dominate the market. [4]

The firms in an oligopoly market are faced with a kinked demand curve and this is for the simple reason that if a firm raises the price of the product it is not followed by others. On the other hand if it reduces its prices he is followed by the others, this is the reason why the demand curve at high prices of the product is quite elastic and at lower prices the demand curve is quite inelastic. [5]

This is diagrammatically illustrated below:

Determination of price and quantity

The average revenue curve represent the demand curve which in this case is kinked, if a firm in this industry raises its price it is not followed by others, if it reduces its price it will be followed by others, therefore the price and quantity in this industry is determined by the price of others, one firm will not raise its prices without considering the decisions to be made by other firms. [6] However sometimes the firms may collude and dominate the market, therefore the price in this kind of market is determined by market forces and in this case they become price takers and sometimes the price is determined by the firms and this case they become the price makers.

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Barriers to entry

Barriers of entry into the milk producing industry is necessary in that it helps in the prevention of unhealthy competition in the industry, if firms were to have free entry and exit then there would be an increase in the level of supply of these products resulting to a very low prices for these products.

Another reason for the barriers to entry is because of health reasons; the government may restrict entry to maintain health standards among the existing firms, in the case where there were many firms it would be difficult to monitor health issues regarding these products and that means health risks to its citizens.

3. PRICING FEATURES OF MILK AND MILK PRODUCTS

Due to the nature of the market structure there exist price wars between firms, firms will reduce prices in order to increase the quantity sold and in turn increase the level of revenue and profits, firms will therefore seem to be in battle field as they try to increase their revenue and profits at the expense of other firms because the market size of milk and milk products is relatively fixed.

Pricing, market structure and economic theory

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Therefore the pricing of these products relates to the economic theory of an oligopoly market, however these firms decisions to raise or reduce prices is made considering the actions of the other firms, advertising pressure by firms also allows them to raise prices and at the same time retain high levels of demand for their products. The pricing decision in the milk and milk products companies are made with reference to the game theory, these theory states that for a firm to make decisions it must consider the actions of the firm. [7]

4. The impact on price and output for a firm in the industry if:

(a) Costs rise due to a rise in advertising expenditure

A cost rise to increase in advertising expenditure will result to no change in the price or quantity of the product produced, if the expenses do not shift the marginal cost curve beyond the vertical range of marginal revenue curve then there will be no price increase and these expenses will be wholly borne by the oligopoly, however if this expenses push the marginal cost beyond the vertical range, the price of this products will rise and therefore these expenses will be borne by the customers, [8] this is diagrammatically illustrated below:

In diagram one the advertising expenses push the marginal cost from MC1 to MC2, this movement is still in the vertical range of the marginal revenue so there are no changes in the price levels of the product. however diagram two illustrate a case where the advertising cost are higher and they cause a shift in the marginal cost curve beyond the vertical range of the marginal revenue, this as result causes an increase in the prices of the product.

(b) The product becomes more fashionable.

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When the products become more fashionable and bearing in mind that one of the factor that influence demand for a product is taste and preferences, we expect that customers will prefer the more fashionable product, this will cause an increase in the quantity demanded of the product, [9] as a result the marginal revenue curve will shift to the

The diagram below shows the effect of this:

The marginal revenue curve shifts from Marginal revenue curve 1 to marginal revenue curve 2, the average cost curve shifts from AR1 to AR2, this shows the increase in demand for the product, however in the long run the marginal cost curve will also shift down ward due to increased economies of scale as a result of the increased demand of the product, economies of scale are realised by a firm when it produces optimally, economies of scale are realised when the firms fixed costs are shared across a large number of unit output and therefore the cost of production goes down, however firms may produce to a level where they no longer realise positive economies of scale and a result realise diseconomies of scale.

OIL PRICES BETWEEN AUGUST 2003 AND AUGUST 2006

During this period there was a decrease in the supply of oil and this led to the increase in the level of prices for oil, this decrease in the level of supply of oil is the increased conflicts in the middle east which is largest oil producing region, war in Iraq, Iran’s nuclear program and the instability in Saudi Arabia contributed to this shortage.

Other producing countries such Venezuela were also facing similar problems such as strikes and political problems, all this problems added to the cost of production where there was a rise in the level of insurance premium, Further terrorist groups targeted oil and gas installation to maximise political gains. Therefore during this period the rise in oil prices can be attributed to the increase in conflicts in the Middle East which is the largest oil producing region and this

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This effect of reduced supply of oil can be diagrammatically illustrated below:

Due to the decreased level of supply, the supply curve will shift upwards from supply curve one to supply curve two as shown in the diagram, also bearing in mind that oil has no close substitute the demand for oil is inelastic and therefore the demand for oil does not decrease in this case. The price rises from P1 to P2 and the quantity decreases from Q1 to Q2 gallons.

THE IMPACT ON GLOBAL OIL PRICES OF THE HURRICANES THAT HIT THE USA IN SEPTEMBER 2005

The hurricane Katrina caused the price of oil to reach an all time high during September; the price of one gallon was 3.04 dollars compared to the previous high price which was 2.38 dollars per gallon. This high price later would be 3.20 dollars per gallon after adjustment for inflation. Therefore the hurricane caused the price of oil to rise beyond the previous high price of global oil prices. [11]

The diagram that depicts these changes caused by the hurricane to world prices and quantity is shown below:

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The rise in the world prices and the decrease in quantity are significantly small compared to the rise in prices and fall in supply of oil between 2003 and 2006. The supply curve in this case shifts upwards from supply curve one to supply curve two, this causes a rise in price from P1 to P2 and also the quantity falls from Q1 to Q2 gallons.

IMPACT OF THE CHANGE IN OIL PRICES SINCE 2003 ON FIRMS THAT PRODUCE MILK AND MILK PRODUCTS

The rise in oil prices since 2003 has caused an increase in the cost of production of milk and milk products, a rise in oil prices is always inflationary and therefore due to the fact that in one way or another oil products are used in the processing and production of milk products then we expect that the cost of production of milk products. However this has led to an increased pressure on the farmer because the price of milk and its products has not increased due the nature of this market, this has resulted in a decrease in the amount produced over the years. [1 2]

A rise in the level of prices for petroleum products will always lead to an increase in the cost of production for all products in an economy; this is because petroleum products are a key input in the production process either directly or indirectly. A rise in the price of petroleum products will always be inflation ally and will cause a rise in prices in almost all the products in an economy.

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Conclusion

Milk producing firms in the UK assume an oligopoly market structure, this structure sometimes is highly competitive while some other times the firms collude and dominate the market. In this type of market the firms always consider the outcome of a decision made to raise or lower prices and the action taken by other firms.

In this type of market if we were to consider a single firm, when an increase in production, increase in taxation or advertising costs go up there is the possibility of two outcomes, the first outcome is where the increase does not shift the marginal cost curve beyond the vertical range then the increase in cost does not result into a change in the price of the product, the second outcome is where the marginal cost curve shifts beyond the vertical range then in this case the price of the product will eventually rise.

In the near future we expect that the companies that produce milk and milk products will exit the industry, this will be caused by the low prices of milk and also the high cost of production to farmers forcing them to stop producing. There is the need for the government to intervene and stabilise this phenomena by subsidising this industry or reducing taxes on milk and milk products.

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However in the long run we expect that there will be a reduced supply of milk and milk products which will push the prices of these products up due to high demand, this will lead to more firms entering the industry and the market forces will stabilise both the quantity and prices of these products. Therefore in the short run we expect that there will be a decline in the growth of this industry while we expect a rise in growth in the long run.

When there is a shortage of oil in any major oil producing oil either due to terrorism or natural disaster such as the Katrina hurricane, the price of oil goes up, these results to an increased cost of production, when the cost of production goes up then the customer prices go up, this is to mean that a shortage in oil products is inflation ally. Oil has no close substitute and is a necessity that drives the economies to growth almost all sectors of an economy rely on oil products either directly or indirectly.

References:

Brian Snow (1997) Macroeconomics: introduction to macroeconomics, Rout ledge publishers, U K

Economic Effects of Hurricane Katrina (2005) retrieved on 15th February, available at www.en. wikipedia.org

Hugh Stratton (1999) Economics: A New Introduction, Pluto Publishers, USA

Keynote publications (2006) Market Reports- Milk & Dairy Products Market Report, retrieved on 16th February, available at www.keynote.org

Mintel International Group (2006) Milk and Cream in the UK, retrieved on 15th February,

available at www. mintel.org

Paul Anthony Samuelson (1964) Economics, McGraw-Hill publishers, USA

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Research and markets (2003) Milk and Dairy Products Market Report retrieved on 15th February, available at

www.researchandmarkets.com/reports/35166/

Oil prices between the year 2003 to 2006 (2006) retrieved on 15th February, available at www. en.wikipedia.org

John Pheby (1988) Methodology and Economics: A Critical Introduction, Macmillan publisher, U K

Ian Livingstone (1970) Economics and Development: an introduction, Oxford University Press, Oxford

Thomas A. and P. Francis (1995) Beyond Rhetoric and Realism in Economics: towards a reformulation of economic methodology, Rout ledge publishers, UK

[1] Keynote publications (2006)

[2] Keynote publications (2006)

[3] Keynote publications (2006)

[4] Samuelson (1964)

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[5] Samuelson (1964)

[6] Stratton (1999)

[7] Samuelson (1964)

[8] Stratton (1999)

[9] Samuelson (1964)

[10] Oil prices between the year 2003 to 2006 (2006)

[11] Economic Effects of Hurricane Katrina (2005)

[12] Oil prices between the year 2003 to 2006 (2006)

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