Question

The banana is one of Australia’s most commonly consumed fruits. Each year, over 95% of households will buy at least one banana and the average person in the population will consume roughly 16kg.

While bananas come in over 1,000 varieties, the Cavendish banana accounts for just over half of global production and 97% of production in Australia. Since the early 2000s, Cavendish bananas have been under threat from a fungus known as Tropical Race 4. This fungus has the potential to make the Cavendish banana go extinct. In response, the Australian government has placed a stringent quarantine policy for the importation of bananas from other countries such as the Philippines, which are the low-cost producers in the region.

Bananas are produced in only a few areas of Australia and the crop is frequently disrupted by typhoons. In this problem set we will explore how these typhoons are likely to impact the decision of farmers to plant bananas and the incentives that exist when a country is allowed to export a commodity but not import it.  

Part 3:  

Since the introduction of the import ban, there have been two serious cyclones that have devastated the banana crop in Australia. In the rest of this problem, we are interested in understanding how the existence of cyclones changes the incentives of domestic suppliers to produce. You should continue to assume that the Australian government bans the import of all bananas and that no other banana producers can enter the market and sell between the planting decision and the harvest decision. You may also assume that all farmers are risk neutral and are maximizing their expected profit.

Question 6: Suppose that in a given year, 110 farmers have chosen to plant bananas and each one has chosen to plant 12,500 kilograms. Prior to the harvest occurring, a hurricane occurs that wipes out the crop of 55 farmers. Draw the resulting supply and demand graphs. What is the new equilibrium price? What is the producer surplus of a farmer who is not affected by the typhoon?

What is the producer surplus of a farmer who is affected by the typhoon? (4 points)

Question 7: Suppose that a typhoon occurs each year with probability 1/12 and that a typhoon will destroy bananas from exactly half of the farmers who choose to plant in a particular year. Calculate the expected profit of each farmer (including the planting costs) if exactly 110 farmers enter the market, and each chooses to plant 12,500 kilograms of bananas. Explain why you would expect additional farmers to enter into the market when typhoons are possible. Discuss what this implies for equilibrium prices in years where a typhoon does not occur. (4 points)

Question 8: Continue to assume that a typhoon occurs each year with probability 1/12 and that a typhoon will destroy bananas from exactly half of the farmers who choose to plant in a particular year. Further suppose that Australian farmers have the option of exporting bananas to the world at a price of $2.00.   Assume that 116 farmers choose to plant in a given season and each farmer produces exactly 12,500 kilograms of bananas. Draw the supply and demand system for the case where a cyclone does not occur. How many bananas will Australia export in this case? Draw the supply and demand system for the case where a cyclone does occur. Calculate the surplus of each farmer (after planting) and show that it is exactly equal to the planting costs. (10 points)

Part 4:

In the article “Economist under fire for banana import suggestion” there is a discussion between Saul Eslake and the Australian Growers industry regarding the importation of bananas in years where a cyclone occurs. Saul argues that Australian consumers could be made better off by allowing imports to occur after cyclones. He writes "Words such as 'greedy', 'grasping' or 'pricegouging', routinely applied to banks, oil companies and airlines, pass nary a lip when it comes to growers… I suppose the difference reflects the fact that when it comes to fruit and vegetables, we are talking about 'our' farmers, who have been 'doing it tough' through drought and now tempest - as opposed to someone else's big, profitable corporations, run by highly paid suits - so that we don't begrudge them the occasional opportunity to indulge in a spot of 'price-gouging'."

The ABGC counters with an argument about biosecurity and the makes the following economic argument: “What Mr. Eslake does not realise is that banana prices are determined by the free market of supply and demand.”

Question 9: Continue to assume that the probability of a cyclone in a year is 1/12 and that a cyclone will destroy exactly half of the total amount of domestic bananas produced and that all farmers who enter will grow exactly 12,500 kg of bananas. Using your knowledge from Questions 1-8 briefly, explain what will happen if the Australian government commits to the following policy prior to planting:  

After each harvest, the government will count the total number of bananas harvested by Australian producers.  

• If the total is above 1,275,000, the government will not allow any imports.
• If the total is below 1,275,000, the government will grant quotas so that the total amount supplied to the market is exactly 1,275,000.

In explaining your answer, be sure to describe:

1. What happens to the prices of bananas in years with a typhoon and in years without the typhoon?
2. The total change in the consumer surplus in years with a typhoon and in years without a typhoon.
3. The total number of bananas planted in each year.
4. The overall impact of welfare for Australian banana growers.

Based on your analysis, would total welfare (consumer + producer surplus) be better off if we could guarantee that there were no biosecurity risks and imports were allowed? (10 points)

Answer 1

6) The figure-1 illustrated in the attached document below portrays the impact of a Hurricane in the banana market in Australia. S1 represents the supply curve of bananas in the market prior to or in absence of the hurricane and S2 denotes the supply curve of the same following the hurricane. The D1 denotes the demand curve for bananas in the domestic market in Australia. Now, assuming that there are total of 110 farmers in the market each producing 12,500 kgs of banana in the market, the total production of banana in the market would be==1,375,000 which is also the equilibrium quantity of bananas in the market, considering that the consumers or buyers demand he equivalent amount of banana in the market. This equilibrium quantity of banana is attained by the intersection of D1 and S1 in future which corresponds to the original equilibrium price of banana prior to the occurrence of the hurricane which is denoted as P*1. Now, following the hurricane, the production level of 55 farmers is destroyed and the remaining amount of banana left in the market is the production level of the rest of the 55 farmers. Therefore, due to the hurricane, the market supply curve of the banana decreases which is indicated by a leftward or upward shift of the banana market supply curve from S1 to S2. Following the outbreak of the hurricane, the total production of banana in the market becomes==687,500 kgs of banana which is the equilibrium quantity of banana after the hurricane disruption. This is the new equilibrium quantity of banana in the market after the hurricane which is formed by the intersection of the S2 and D1 curves and the new equilibrium price following the hurricane becomes P*2. Further observe that due to hurricane and the consequent reduction in the production level of bananas, the equilibrium price of bananas in the Australian market increases from P*1 to P*2, holding the market and all other relevant market factors constant. The producer surplus of the farmer not affected by the hurricane is indicated by the area E+F and the same for the one affected by the hurricane is given by the area B.

7) The probability of the occurrence of a typhoon is 1/12 or 0.083 approximately and hence, the probability of typhoon not occuring=(1-0.083)=0.917 approximately. The typhoon will destroy the production level of 55 farmers from the total of 110 farmers in the market and each farmer produces 12,500 kgs of banana. Hence, the revenue generated by each farmer if the typhoon does not occur= and let's suppose that the marginal cost of producing one banana is C and thus, the total cost of producing banana in the absence of typhhon=. Now, if the typhoon occurs, the revenue generated by each farmer becomes= and the total cost of banana production remains at 12,500C.

Hence, the expected profit of each farmer considering the probability of both the occurrence and absence of typhoon=0.083*(1,375,000*p*1-12,500C)+0.917*(687,500*P*2-12,500*C)=114,125P*1-1037.5C+630,437.5P*2-11,462.5C=114,125P*1+630,437.5P*2-12,500C

Considering that typhoon does not occur, the overall or total market supply of bananas will be relatively higher than otherwise compared to the market demand for bananas and price of the bananas will be comparatively lower when relative to the years of the occurrence of the typhoon. Furthermore, even if the typhoon occurs and destroys the production level of half of the farmers, some farmers will still prefer to enter the banana market in Australia due to positive economic profits earned by the rest of the farmers when if the production level decreased. Note that the price of the bananas increased and the total cost of planting and producing bananas has remained the same, which can perhaps lead to positive economic profit for the farmers.

8) Considering that the typhoon does not occur and all the 116 farers are operating or producing in the market, the total production of bananas in the market==1,450,000 kgs and if there is a typhoon and half of the farmer's production level is destroyed, the total market production becomes==725,000 kgs. Without the typhoon, the equilibrium quantity and price of bananas would be 1,450,000 kgs and P*1 respectively corresponding to the intersection of S1 and D1 curves and following the occurrence of the typhoon, the equilibrium quantity and price of bananas would be 725,000 kgs and P*2 respectively. The amount of export prior to the typhoon is indicated as the difference between Q2 and Q1 in figure-2 and the export level after the typhoon is reduced to (1,425,000-Q1) due to reduction in the overall market supply of bananas. The producer surplus before the typhoon would be the entire area below area A and after the typhoon, the producer surplus would be reduced to area B+C+E+F in figure-2.

9) In this particular instance, notice that both the equilibrium quantities of bananas of 1,375,000 kgs and 1,450,000 kgs for 110 and 116 farmers respectively are both higher than the parameter stipulated by the Australian government which is 1,275,000. However, if the typhoon or hurricane occurs, observe that the equilibrium quantities decrease to 687,500 kgs and 725,000 kgs. In such circumstances, based on the government stipulation if the import quota of 1,275,000 is imposed in the market, it will generate a shortage of bananas in the market, as at that particular quantity quota, the market demand of bananas will exceed the overall market supply and the shortage amount has to be imported from the international market. The market shortage would reasonably lead to an increase in the banana price in the domestic market in Australia and both the consumer surplus and producer surplus would decrease in the banana market in the country. The shortage of banana supply and the higher banana price in the market would essentially cause an overall decline in the economic welfare in the Australian banana market which is calculated by the summation of both the consumer and producer surplus in the market. Hence, a reduction in both consumer surplus and producer surplus would consequently lead to a reduction in the overall economic welfare in the Australian banana market. Hence, any such import incentivization by the Australian government would hurt both the consumers and producers in the domestic banana market, considering the economic welfare of both the entities.