Espresso Coffee Market – Monopolistic Competition

The free trade agreement allows Australia to freely trade beef to the Canadian economy at the world price. The impact of free trade on consumer, produce and overall social welfare of Australia is illustrated in the figure below.

Domestic market demand and supply of beef in Australia is represented by the respective curve denoted as DD and SS. Without trade, domestic price and quantity is determined by the domestic supply and demand condition (Viner 2016). Price then is settled at P* and equilibrium quantity of beef is at Q*. As Australia involves in free trade, domestic producers face a higher world price at Pw. With a higher world price domestic supply of beef lowers to Q₁ from the earlier equilibrium position of Q*. While domestic supply increases to Q_2.  The excess of supply (Q₂ – Q₁) is now exported to Canada. After trade, the high world price reduces consumer surplus from (A + B + C) to A only. The surplus to producers following free trade increases from (D + E) to (B + C + D + E +F). As gain in producer surplus exceeds the loss in consumer surplus there is a net gain in welfare of Australian economy indicated by the area F.

In the above figure P_FT shows free trade price of beef in the world market. At this price, domestic supply of beef is lower than that of domestic demand resulting in an import of exceed demand shown by the blue line in the above figure. Now suppose, Canada imposes an import quota which restricts the imported quantity indicated by the red line. The imposed quota leads to an immediate shortage of beef in Canada raising import price in Canada to P₀^IM. Price of beef in the exporting nation on the other hand lowers to P₀^EX. Equilibrium price in Canada thus reached to the level where import demand matches with the quota level (Feenstra 2015). Consumers in Canada suffers from a loss in surplus by the area (A + B + C +D).  Increase in price of imported beef and that of domestic substitute lower the consumer surplus. Quota on the other hand benefitted domestic producers of Canada. Producers gain a surplus as indicated by the area A. The increased price of beef I creases producer surplus. From the Quota, government earns a quota rent shown by the area (C + G). The economic efficient or aggregate welfare depends on gain in producer surplus, loss in consumer surplus or rent from the imposed quota. The net impact on importing nation can either be positive or negative (Leamer and Stern 2017). Net change in welfare is given as G – (B + D). Now, if the quota rent exceeds that of the loss in consumer surplus, then there is a welfare or efficiency gain to Canada.

Factors Behind an Explosion of Coffee Chains in Australia

The imposed import quota by Canada is lower than the export volume of Australia. The quota is thus binding in nature. Export price of beef in Australia lowers from the quota restriction. Price in Australia continues to fall unless supply of export is equivalent to the imposed quota level. The higher price of Australian beef lowers the exported quantity to (S₀^EX –  D₀^EX) from (S₁^EX –  D₁^EX) before the quota. Consumers of Australia enjoys an increase in surplus resulted from lower price. Consumer surplus increased by the area e. The quota restriction lowers the gain to producers as resulted from a decrease in prices in both domestic and export market (Ciuriak et al. 2015). The loss is producer surplus is given as (e + f + g + h + i).  There is an aggregate loss in welfare in Australia by (f + g + h + i).

The import quota imposed by Canada lower the export volume of beef from Australia to Canada. In order to encourage beef export overseas to other nation government decides to offer a subsidy to beef export. Before the subsidy, the volume of beef export in Australia is shown as (S₀^EX – D₀^EX).  Now suppose, government offers a subsidy of ‘S’ to the beef exporters in Australia. The subsidy increases price in the domestic market to P_S^EX ₍Hamilton 2017). The higher price encourages producers to supply more beef which increase supply of beef to S_S^EX from S₀^EX. The higher price reduces beef consumption to D₁^EX from D₀^EX. A higher quantity of beef is thus exported overseas. The export volume of beef increases to (S_S^EX – D_S^EX).  The export subsidy increase price of beef in the domestic market while reduces the same in the export market. Australian consumers now experience a lower surplus. Surplus to consumers in Australia lowered by the area (a + b). Beef producers on the other hand gain from an increased volume of export and associated increase in price. Increase in producer surplus is shown by the area (a + b + c). Government has to make the subsidy payment (Broocks and Van Biesebroeck 2017). The cost to the government is (b + d + f +g + h + i). This lower government revenue as subsidy payment has to be made out of the budget.

The espresso coffee market can be classified as a monopolistically competitive market. In this form of market, a considerably large number of sellers sell a differentiated product. With increase in demand, the number of café shops in Australia has increased. Each coffee shop tries to differentiate the offered drink by adding some spatiality (Baumol and Blinder 2015). As demand is not infinitely elastic, market demand curve slopes demand curve. Here, firm is a price maker instead of a price taker.

Impacts of Free Trade on Beef: The Case of Australia and Canada

The main reason behind an increase in coffee chain explosion in Australia is the increased preferences and hence, an increased demand for coffee. The increased demand increases price of coffee and profitability of café shops. Preferences of coffee has also been shifted from instant coffee to espresso coffee. Not only volume of coffee demand increases but also there is change in preference pattern. People now demand premium brew even at a higher price. The increases in demand and associated higher profitability attracts more coffee seller which lead to an increase in coffee chains in Australia (Cowell 2018).

Using the above demand- supply model, it can be said that demand curve shits outward (D₁D₁) with the increase in preference of coffee. This causes an increase in both equilibrium price and equilibrium number of coffee shops in Australia.

Under monopolistic competition, it is not possible for firms to make a positive economic profit in the long run. Positive profit in the short run attracts more sellers to enter the market. If there is an abnormal profit in the market, then more coffee shops, restaurant and other outlets will be opened up. This increases the supply of coffee in the industry. As buyers have a wider choice of coffee price in the market would be lower which in turn reduces profitability (Carlton and Perloff 2015). In the long run thus firm could only enjoy a normal or zero economic profit.

If government offers a subsidy in the market, then that would increase profitability of the firm. Any proposed subsidy increases price received by the sellers while reduces the price to the buyers. The impact of a subsidy can be understood using the following figure.

The immediate effect of a subsidy is to increase the supply. This is shown from movement of the supply curve in the outward direction. Price to firms is P_S while price to buyers is P_B. The difference between the price is paid by the government. Subsidy thus benefits both buyers and sellers.

As discussed above, subsidy increase the price received by the firms. Given the cost, the increased price increase profit margin by lowering average cost significantly below the market price (Belleflamme and Peitz 2015). Firms in the short run thus able to make a positive economic profit.

References list

Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Nelson Education.

Belleflamme, P. and Peitz, M., 2015. Industrial organization: markets and strategies. Cambridge University Press.

Broocks, A. and Van Biesebroeck, J., 2017. The impact of export promotion on export market entry. Journal of International Economics, 107, pp.19-33.

Carlton, D.W. and Perloff, J.M., 2015. Modern industrial organization. Pearson Higher Ed.

Ciuriak, D., Lapham, B., Wolfe, R., Collins?Williams, T. and Curtis, J., 2015. Firms in International Trade: Trade Policy Implications of the New New Trade Theory. Global Policy, 6(2), pp.130-140.

Cowell, F., 2018. Microeconomics: principles and analysis. Oxford University Press.

Feenstra, R.C., 2015. Advanced international trade: theory and evidence. Princeton university press.

Hamilton, C., 2017. Import quotas and voluntary export restraints: focusing on exporting countries. In The Political Economy of Manufacturing Protection (pp. 214-234). Routledge.

Leamer, E.E. and Stern, R.M., 2017. Quantitative international economics. Routledge.

Viner, J., 2016. Studies in the theory of international trade. Routledge.