Alcohol pricing in the Australian market

1. Alcohol is an intensive part of the life of Australian. Price of alcohol in the Australian market is high due to high demand. The price of 1 bottle whiskey of 700ml costs $25.33 in the world market and it costs $37 in Australian market. Beer is the most popular alcohol in among different types of alcohol, with lesser price. It costs $17.99 in Australian market and $9.79 in world market (Doran et al., 2013). Over the years the change in alcohol price has no significant effect on the demand of alcohol. Demand for alcohol is highly price inelastic.

For example, P1 = $17.99 and P2 = $ 30 Q1= 700 ml, Q2 = 600 ml 

In this situation, impacts of excise tax and price floor are examined below.

Impact of Excise Tax 

Figure 1: Impact of excise tax on consumers

(Source: created by author)

As shown in the figure, if government imposes the excise tax by the amount t per unit, there would not be any significant impact on the quantity demanded for alcohol in the Australian market. As tax imposed on the sales per unit in the form of excise tax, supply curve shifts upward by the amount of tax (Sharma, Vandenberg & Hollingsworth, 2014). Quantity demanded only falls from Q1 to Q2, which is significantly less compared to price hike. Incidence of tax burden is completely borne by the consumers.

Impact of Price Floor

Price floor is used by the government to impose restriction on price reduction. It is the indirect method of restricting consumption. As described by Holmes et al. (2014), when government wants to reduce over use of alcohol, price floor can be used. Government imposes a price externally, below which market price of the product cannot fall. Rice floor can be set below or above the equilibrium point. Price floor below equilibrium price has no real impact on the alcohol consumers and the producers as the high market demand always keep the price at a higher level (Osterberg, 2012). Therefore, the aim of the government is to keep the price floor above the market equilibrium price. 

Figure 2: The impact of price floor on consumption

(Source: created by author)

P1 and Q1 is the market equilibrium price and quantity. In this situation, imposition of price floor creates increases price to Pf. Higher price induces supplier to provide more products in the market. There is no impact on the demand and hence, no movement of demand and supply curve. Excess supply is created in the market. This situation cannot sustain in the long term and hence, impact is greater on the suppliers compared to consumers (Patra et al., 2012). In order manage the excess supply, either government or suppliers need to absorb the excess amount.

Impact of excise tax on alcohol consumption

Relative Benefit

Both the government initiatives have no significant impact on the alcohol consumption. However, excise tax has greater effect while considering economic welfare. Excise tax increases government revenue, which further may increase government spending in the economy. Price floor has no such benefits for economy, suppliers or consumers.

2. a)

Figure 1: Long run equilibrium under monopolistic competition

(Source: Author)

The long run equilibrium price and quantity for the table manufacturer, under monopolistic competition has been illustrated in figure 3. The lowest point of the LRAC curve, i.e. R, gives the price P2, i.e., $200 and quantity Q2. At R, LRMC cuts the LRAC curve from below. However, under monopolistic competition, the equilibrium occurs at point T, i.e., where LRAC is equal to AR or demand curve (D), and LRMC equals marginal revenue (MR). The profit maximizing price for the table manufacturer would be P* at quantity Q*. Here, P* > P2. Thus, he would charge higher price than P2 = $200 for profit maximization (Kirzner, 2015).

b) Oligopoly is a market structure of imperfect competition. The main features of oligopoly are few sellers, many customers and differentiated products (Hall & Lieberman, 2012). The other features include:

• non-price competition due to product differentiation;
• high level of barriers to entry for a new firm;
• group behavior of the firms, i.e., actions of one firm affect the same of the others;
• interdependence of the firms regarding any business decision;
• existence of price rigidity and absence of price wars among the firms to avoid losses; and;
• absence of uniformity regarding the sizes of the firms.

The major oligopolistic industries of Australia are Grocery retail, Banking and Media. The grocery sector is dominated by Coles and Woolworths with 70-80% market share. The major banks dominating the banking industry are ANZ, Westpac, NAB and Commonwealth Bank. News Corporation, Fairfax Media and Time Warner dominate the media sector (Denniss & Richardson, 2013).

All these three industries are characterized by few firms and many customers. They sell differentiated products in the respective sectors. Thus, the level of non-price competition is quite higher in these sectors. There is group behavior among the firms. The pricing or any other business decision of one firm affects the others and they react with another action. The firms have price rigidity, as the involvement in price wars would lead to significant revenue loss. There is barrier to entry for new firms in all the three sectors, as the new firm has to compete with already established firms and effective pricing policies (Wu & Shen, 2013)

c) Monopolistic competition is a market structure with imperfect competition, featured with many sellers and many buyers. In this market, the products are not perfect but close substitutes of each other. A single firm has limited power to control the market (Zhelobodko et al., 2012). The other features include:

• Product differentiation based on brands, shapes, sizes, packaging, colors, etc.
• higher level of non-price competition
• freedom of entry and exits of the firms due to lack of barriers to entry
• absence of perfect information about the products and prices
• independence of the firms in terms of decision making as the decision of one firm does not affects the others much
• there is elastic demand in the market (Balistreri & Rutherford, 2013).

Impact of price floor on alcohol consumption

The monopolistically competitive industries in Australia cover a broad range of products. Consumer goods, beverage industry and restaurant business are such industries in Australia. All these industries have many consumers and many producers. The products are highly differentiated, leading to very high level of non-price competition. The price of one firm has very less effect on the pricing decisions of other firms. The limited market power enables the firms to take independent decisions. The firms have freedom of entry and exit in the market. There is also absence of perfect information about the products among the consumers in the respective industries. For example, it is impossible for a single consumer to know every detail of all the restaurants in a particular region, and this knowledge drives the decision making of that consumer (Gilmour, 2013).

d) Duopoly is a market structure with only two firms and many consumers. When there is no third seller of a product in the market; and monopoly power exists due to differentiated products, then natural duopoly exists in the market (Jena & Sarmah, 2014).

A major economic model revolving around duopoly is Cournot model. It plots the reaction curves of two firms in the diagram. The reaction curve represents the profit maximizing production of one firm in relation to the expected production of the other firm. Hence, the produced quantity of one producer is a declining function of the output of the second firm (Naimzada & Tramontana, 2012).

Figure 2: Natural duopoly equilibrium

(Source: Author)

The Cournot equilibrium for duopoly is illustrated in figure 4. The two reaction curves depict the outcomes of one firm in relation to the expected outcome of the other. Here, point E’ is the equilibrium. At this point, both the firms are able to predict the other firms output correctly and produce accordingly to maximize profit. At this point, there is no situation for a new firm to enter and make profit.

References

Balistreri, E. J., & Rutherford, T. F. (2013). Computing general equilibrium theories of monopolistic competition and heterogeneous firms. Handbook of Computable General Equilibrium Modeling, 1, 1513-1570.

Denniss, R., & Richardson, D. (2013). Corporate power in Australia.

Doran, C. M., Byrnes, J. M., Cobiac, L. J., Vandenberg, B., & Vos, T. (2013). Estimated impacts of alternative Australian alcohol taxation structures on consumption, public health and government revenues. Med J Aust, 199(9), 619-622.

Gilmour, P. (2013). Benchmarking supply chain operations. International Journal of Physical Distribution & Logistics Management.

Hall, R. E., & Lieberman, M. (2012). Microeconomics: Principles and applications. Cengage Learning.

Holmes, J., Meng, Y., Meier, P. S., Brennan, A., Angus, C., Campbell-Burton, A., … & Purshouse, R. C. (2014). Effects of minimum unit pricing for alcohol on different income and socioeconomic groups: a modelling study. The Lancet, 383(9929), 1655-1664.

Jena, S. K., & Sarmah, S. P. (2014). Price competition and co-operation in a duopoly closed-loop supply chain. International Journal of Production Economics, 156, 346-360.

Kirzner, I. M. (2015). Competition and entrepreneurship. University of Chicago press.

Naimzada, A. K., & Tramontana, F. (2012). Dynamic properties of a Cournot–Bertrand duopoly game with differentiated products. Economic Modelling, 29(4), 1436-1439.

Osterberg, E. (2012). Pricing of alcohol. Alcohol in the European Union: consumption, harm and policy approaches. Copenhagen, WHO Regional Office for Europe, 96-102.

Patra, J., Giesbrecht, N., Rehm, J., Bekmuradov, D., & Popova, S. (2012). Are alcohol prices and taxes an evidence-based approach to reducing alcohol-related harm and promoting public health and safety? A literature review. Contemporary Drug Problems, 39(1), 7-48.

Sharma, A., Vandenberg, B., & Hollingsworth, B. (2014). Minimum pricing of alcohol versus volumetric taxation: which policy will reduce heavy consumption without adversely affecting light and moderate consumers?. PLoS One, 9(1), e80936.

Wu, M. W., & Shen, C. H. (2013). Corporate social responsibility in the banking industry: Motives and financial performance. Journal of Banking & Finance, 37(9), 3529-3547.

Zhelobodko, E., Kokovin, S., Parenti, M., & Thisse, J. F. (2012). Monopolistic competition: Beyond the constant elasticity of substitution. Econometrica, 80(6), 2765-2784.