Microeconomics Case

Part a:

In economics sense autarky is defined as being self-sufficient, when a nation can provide all of the goods and services it needs internally. While free trade is a condition where a nation removes barriers to allow for international trade ( Ethier 2008). In Australia the banana industry is heavily protected by a "zero import" ban on imports of banana, creating a condition that benefits the producers more than the consumers.

Producer surplus is defined as the minimum amount that they are willing to accept for a good, the difference between the actual and minimum they receive is the benefit the producer receives. On the other hand consumer surplus is the minimum amount they are willing to pay for a good or service relative to the market price, the difference between the what the consumer is willing to pay and the market price is how it occurs (Hubbard et al. 2010, 131-133).

The figure below (Fig 1) illustrates the Australian banana market in autarky and free trade positions and show how an increase in consumer surplus occurs under free trade position and how producer surplus decreases.

Exposing the Australian banana industry to free trade economy will mean a lift on the ban for banana imports. Under autarky the economy is at equilibrium point A with price P1 and quantity Qs. At point A, consumer surplus is equivalent to a+d=$585m while producer surplus is b+e+f=$135.

Under free trade price of bananas moves from P1 to P2 and the quantity supplied by the banana producers reduces from QA to QS. The reduction in prices is caused by the world price effect but this reduction in price has negative and positive effects on consumer and producer surplus.

At point D, producer surplus is e while consumer surplus is a+b. A deadweight loss occurs and is denoted by the regions d and f because of a loss in economic efficiency. This is occurs after the introduction of free trade. Producers are now forced to lower their prices in order to compete with the imports however some producer might decide to stop producing all together causing the quantity supplied to reduce from QA to QS. Consumers are set to gain more from introduction of free trade over producers, this was evident by the increase in consumer surplus from $585m to $760m while producer surplus reduces from $135m to $69m. Furthermore at point D, the quantity demanded is more than the quantity the domestic suppliers are willing to produce. This gap between quantity demand and quantity supplied is the size of imports.

Point B is the equilibrium point for the free trade position with price at P2 and quantity of bananas at QD. Australian consumers will be able to purchase bananas in Australia at a reduced price while producers will not be able to sell their products at the same price as they used to.

Part b:

Bananas are one of the biggest selling individual item in supermarkets across Australia after cyclone Yasi wiped 90% of the banana supply for Australia causing prices to fold 5 times over. Government intervention is required, from the above figure, it is recommended that the Australian government lift its import ban on bananas and introduce quarantine measures to reduce the threat of diseases than can jeopardise the local producers.

It was identified that only 21 of the 122 species of potentially harmful pests and diseases were of unacceptable risk level and that if controls were in place the risk level would be significantly reduced because disease like "tropical race four Panama" which have been flagged as one of the 21 of unacceptable risk is a soil borne disease carried by the plant and not the fruit. This total ban approach of the government is unnecessary (Hartwich and Gill 2011). Japan and New Zealand import bananas but with very strict control measures.

However Kevin Fox, head of Economics at the Australian School of Business and director of the Centre for Applied Economic Research. Lamented the lack of consumer raising the issue in the public debates and that when weight up the benefits to the economy as a whole were more, thought it is true a lift in the import ban would leave the local producers at risk of pests and diseases while also increasing competition in the market but this would mean the consumer would not have to pay the price for their protection. Sustaining inefficient production systems and artificially high prices that way is unethical (The price 2011).

Furthermore it is recommended that production in Australia shouldn't be done only in Queensland but rather diversify more in order to avoid a similar price rise.

Part c:

Assume that the income elasticity of bananas is zero and that retailing prices of banana rose by 5 folds also assume that the low and high income family group have similar preference structures.

Income effect is defined as the change in consumption from a change in income while substitution effect is the change in consumption resulting from a change in price accompanied by a change in income leaves the