Question

Question

Robots in the factory and price rise for suppliers as Maleny Dairies invests

for the future ABC News, 28 November 2019

At a desperate time for the dairy industry, with droves of farmers making the tough decision to quit, a determined Sunshine Coast couple is staking their financial future on upgrading their processing plant and keeping local farms in business.

In the past five years Ross and Sally Hopper have spent about $10 million upgrading Maleny Dairies' factory.

It was founded in 2000 by Mr Hopper's late parents Harold and Dorothy — dairy farmers who foresaw the difficulties ahead after deregulation.

At the turn of the century there were 1,500 dairy farms in Queensland; now there are about 300.

The Hoppers' most recent $2.5 million investment included installing two crate-stacking robots to cut down on spiralling casual overtime costs and speed up deliveries to their distribution centres at Caboolture and the Gold Coast, and to IGA's major depot in Brisbane.

"We're looking forward to the future, we can see a future in our domestic milk and yeah automation is obviously a way of moving forward," Mr Hopper said.

Task:

Describe what you think some of the key costs would be for Maleny Dairies, and detail which are fixed costs and which are variable costs.

How do you think their current investments would impact their cost structure?

Depict these changes on a diagram (or diagrams) showing their ATC, AVC and MC under their old cost structure and under their new cost structure and explain how this shows the changes that you have proposed.

Answer 1

A typical dairy faces many costs, and the case of Maleny Dairies can be highlighted as under:

Fixed costs: Factory - plant and equipment, Land, Building, Fixed components of salaries, Taxes, Insurance, Rental payments

Variable costs - Raw materials, Electricity, Labor (variable component as per production)

Of course, the distinction between fixed and variable also depends on the time horizon. Over a long period of time, most costs become variable. In the given case, the investment in robots is a long term decision, hence it is fixed in the short run.

The above diagram shows a state of initial equilibrium, where the MC curve crosses the ATC curve at lowest ATC.

AVC falls initially, and then begins to rise.

With the dairy's current investment plan, the fixed costs rise. We will initially assume that variable costs remain the same.

We know that Total cost = Fixed cost + Variable cost

TC = FC + VC

Now, if FC rises, as in this case, TC will also rise.

Further, in average terms, dividing all terms by Q (quantity)

ATC = AFC + AVC

Now in the future, the quantity that the dairy can produce may also rise, i.e., Q may also rise. If Q rises substantially, then the overall average costs may fall.

The diagram doesn't show AFC, which starts at a high cost, and begins to fall gradually. It is this AFC curve which shifts to the right, due to an increase in fixed costs.

The graph below only shows the initial impact of a rise in fixed costs, for the Maleny Dairies.

The rise in fixed costs pushes the Average Total Cost upwards. There may not be any change in the AVC curve, as variable costs have not changed (no information given). If variable costs don't change, MC will also not change.

The rise in ATC due to the rise in FC, pushes the cost structure upwards, and this means that the dairy may have to charge a higher price for its products, to recover the costs.

We know that Profits = Total Revenue minus Total Costs

Hence, a higher price has to be charged to recover the higher costs.

(This may change in the future, because the dairy will be able to produce much more Q eventually, bringing down the ATC)

This can be shown as under: