Question

The Cost of Producing Wine at Only a Small Fraction of the Price

Based on Dana Nigro, “What’s Behind the Bottle Price?” Wine Spectator, December 15, 2002:50–56.

Most consumer goods are not sold by the manufacturer. Instead, they are produced by the manufacturer, who sells to a wholesaler, who in turn sells to a retailer, who sells to the public. Such is the case with most wine.

There has been an outcry in recent years over increases wine in prices. Although prices have risen sharply, the multilevel market structure and the markup that occurs at the wholesale and retail levels have a much larger role in the price increases than the production of the wine itself. Total production costs for a typical $24 bottle of wine are just $4.92, or about 20.4% of the final price, whereas wholesale and retail markups together make up 40% of the final price. Not surprisingly, raw materials (grapes) are the single biggest cost. The cost of the grapes may be as much as 60% of total production costs but varies greatly from lower-quality inexpensive wines to the highest quality wines. The second-highest cost for many vintners is the barrels used to ferment the wine. French oak barrels cost as much as $700 apiece and last only a few years. The other major production cost, other than the actual physical plant where the winemaking occurs, is time. Quality wines spend 2–2 ½ years aging in barrels and then an additional 8 months in bottles before being ready for sale.

1. How much substitutability do you suppose exists between inputs in winemaking? How might this factor affect efforts to cut costs?
2. If a firm were to find a new technology that cut the required aging time in half, how would it affect the demand for other inputs?

Answer 1

a. According to me the substitutability betwee inputs in winemaking is very less, this means that the inputs used in the production of wine have no close substitutes as production of different types of wines need different (but particular) types of inputs. So the inputes used in production of one type of wine cant be used in other type of wine.

This factor makes it very difficult to cut costs, this is because since there are no substitures for the inputs so even if the price of an input increases the manufacturer has to use the same input which increases cost, they have no option for any cheaper input which can decrease cost.

b. If a firm were to find a new technology that cut the required aging time in half, we can see an increase in the demand for other inputs. This is because Previously when the aging time was 2 years, so during this two years there would be no use of other inputs because production couldn't be carried on with those inputs. But now when the aging time is about 1 year so the production could be carried out on a large scale because the main input will be ready in 1 year. So large scale production will require larger amount of other inputs.