Australis Research Solutions

Cork Pop On Prices

By Philip White

The Australian wine industry is about to experience its most dramatic change: prices are going to soar. The local wine business is in constant flux, and there are pundits who thought the dramatic restructurings of the past few years were really something. Wait until they see this.

Selling bulk wine sales has long been a huge business in Australia. It is tanked, or bottled as unlabelled "cleanskin" wine. It comes from companies that, once everything is bottled and sold under their own labels, they find themselves with a handy surplus that they float on the open market to the highest bidder.

A look at the companies with big wine sales but few vineyards shows where the stuff goes. Orlando, for example, has Jacobs Creek claret, Australia's biggest-selling bottled red. The Jacobs Creek vineyard is tiny. Wolf Blass, maker of Australia's biggest-selling riesling, especially his Yellow Label, has just established his first vineyard, and that is pretty small. These people, among hundreds of others, buy most of their wine.

Lindemans has substantial vineyard holdings and is a traditional seller in this grey market. If one looks, and somehow can get them to admit it, it is possible to find wine makers who have had standing orders of, say, 100,000 litres of chardonnay from Lindemans of each vintage. It forms a handy supplement to the wine they have grown and made themselves. This year, quite suddenly, such wines are not available. It is being exported. The grey market is drying up.

To make things worse, the 1987 vintage will be short. Yields will be low throughout Australia. The state and federal governments' vine-pull scheme has not helped, with millions of dollars going to those who uproot their vines and get out of the business.

Since the minimum pricing structure was demolished, grape prices have soared, and traditional sellers such as the McLaren Vale vignerons are laughing all the way to the bank. Since last year, the prices offered for their grapes across the board have doubled.

Many of the traditional bulk suppliers have empty tanks. John Swann, one of the biggest bulk wine brokers, says: "This time last year, I had access to between 15 million and 20 million litres of white, and 12 million to 15 million litres of red. Now I've got five million of each, and that's going very, very quickly."

The traditional buyers of this wine now have only two choices. They can pay more to keep the volumes of their market-leading blends up, or they take a dive in quality and flesh the blends out with cheaper fruit. Because there is hardly any of the latter available, the price has to rise. And with the recent technological advances, the quality of bottom-drawer stuff has improved, again meaning price rises.

The dollar's drop against the French franc has caused dramatic increases in wine-making equipment. Crushers, presses, bottling machines and the like are nearly double the old price. A new French oak barrel has risen from about $400 to nearly $700. Soon, the words "new French oak" on a label will mean an extra dollar on the price tag.

The industry captains are, at best, guarded about the extent of these hikes. Guenther Prass, managing director of Orlando, says "Yes, there will be an increase in the cost of premium wine. The increased production costs will have to reflect on the prices we charge the consumer."

It is difficult to find anyone to volunteer an estimate of how much margin, over and above the obvious production cost rises, can be squeezed from the consumer before the turn-off point is reached.

One thing is certain, however. The price rises already endured by the marketplace - tax-related or due to increased production costs - have been tolerated only because the consumer has become a more appreciative, quality-conscious buyer. Australian consumer awareness has increased as quickly as the wineries have been able to improve their products. It seems highly unlikely now that the quality improvement rate will continue to rise in line with prices.

Business Review Weekly 17 October 1994

It is now late-1994 and there have been some remarkable developments in the Southern Vales over the past few years. The vine-pull scheme was oversubscribed, but the State and Federal Governments funded all applications. As a result more than ten per cent of the region’s vines were pulled out. However, not just the older, less popular, less productive vines. Many younger vines and popular varieties, such as Chardonnay, were removed. As were some of the very vines on which the reputation of the region as a wine making region was built. For example, an entire vineyard of 130 year old shiraz grapes was pulled out and replaced with prune trees! Moreover, storms in 1987 also reduced the size of that year’s vintage by a further ten per cent. The total reduction in output of some 20 per cent during the last half of the 1980s has been accompanied by a modest, but welcome, increase in prices. For example, this year premium Pinot Noir grapes are expected to sell for $1,200 per tonne, which is double last year’s price and six times the $200 they sold for in 1986, if growers could find a buyer. Most growers in the region are looking forward to making their first profits for years. Zoë and Matthew feel vindicated in their decision not to apply for any vine-pull funding. Moreover, Zoë and Matthew have been fortunate as they have suffered no ill effects from these extreme weather events and are expecting to harvest a bumper crop this vintage.

The recession of 1989 to 1991 severely affected the Southern Vales, largely as a result of the high proportion of ultra premium and super premium wines that are produced in this region. This recession, although it was deep, it was short, and hence the recovery was well under way by 1993 and the recovery was pretty much complete by 1996, just in time for the Asian Financial Crisis of 1997/98. The quick rebound in the Australian economy meant that the wine industry in the Southern Vales also recovered quite quickly.
Another development has occurred in the region. The winery that Matthew works for was a large family owned winery. However, it was recently bought by an interstate brewing company that also has extensive winemaking interests in the eastern States. The company that Matthew works for has essentially been swallowed by this large interstate competitor, which now controls all aspects of production from its corporate headquarters in Melbourne. Matthew no longer has the freedom to develop the new wine styles that are being demanded by an increasingly sophisticated market or to develop new production methods. All such product development takes place in the Hunter Valley, in wineries that the Victorian based conglomerate has owned for decades. He is now just another cog on the machine. Matthew is becoming quite disillusioned about where his career as a promising young wine maker is headed.
So, Matthew has decided to use the wine making facilities that this father installed at Duloc as an outlet for his entrepreneurial talents. He feels that some of the older, unpopular bush varieties, in particular Grenache, which is often used to make fortified wine such as port, can be used to make super premium and ultra premium table wines instead of fortified wines. He has decided to produce a couple of premium wines, a rose and a sparkling burgundy, using Grenache. He sees this as a bit of a sideline and so he has decided not to resign from his day job. His limited production is sold thorough the cellar door and at a few local restaurants who support local small winemakers.
Prior to undertaking her PhD, Zoë completed a commerce degree, majoring in accounting and economics, at the University of Adelaide. So, it has been agreed that she will be the business manager for Duloc. She feels that at the moment she can do this on a very part-time basis in her spare time. However, she is strongly of the view that Matthew should make the fullest use of the grapes he produces and his father’s wine making facilities to make large volumes of low quality wines, that are readily sold in bulk to large wineries for blending into low end or basic bottles, as cask wines or even coolers. Moreover, there is currently a real shortage of “grey wine” and Zoë feels that Duloc can readily take advantage of this opportunity.
The Southern Vales is referred to a “cool climate” wine producing region. Moreover, the vines are not irrigated so the yields are low and can vary considerably depending on the winter rain fall and summer temperatures. The yields are typically five to eight tonnes per acre. On the other hand, the Riverland, i.e. based on the towns of Waikerie, Barmera, Berri and Renmark is referred to as “warm climate” wine region. However, this is an irrigated wine region drawing water from the Murray River. Yields tend to be higher eight to ten tonnes per acre, even higher for some varieties, and the yields are less variable due to the availability of irrigation water. A tonne of grapes produces 700 litres of grape juice and hence 700 litres of wine. So, currently Matthew and Zoë could conceivably produce 280,000 litres of grey wine and sell it for 50 cents per litre. On the other hand, super premium wines sell for $10 to $15 for a 750 millilitre bottle, i.e. $13 to $20 per litre.

Note:
Grey wine is not grey in colour, wine only comes in three colours, red, white and rose (i.e. pink). Grey is just a short hand term for bulk, usually low quality, wine that is used for blending or ends up in flagons, casks, wine coolers or even distilled to make grape spirit, i.e. pure ethanol, which is then used to make brandy or to increase the alcohol content of port and other fortified wines.

Topic 3

Week 4

Supply

Questions

Hints

Explain the law of supply and explain why the supply curve slopes upwards. Explain the difference between a change in supply and a change in the quantity supplied, illustrate your answer with appropriate diagrams. Outline the non-price determinants of supply and then explain why grape prices have risen recently. Ignore any demand side factors at this stage. Illustrate your answer with a firm/market diagram. Why can it be argued that a bumper harvest is often bad for farmers? What farmers, crowing what kinds of crops, might like a bumper harvest? What does the term “derived demand mean”? How does this concept apply to the situations addressed by this case study? Illustrate with examples. Do, you agree with Matthew’s decision to produce small quantities of premium quality, boutique wines rather than to produce large volumes of bulk wine production, which, given his reputation as a wine maker, he can sell readily to local wineries instead of selling grapes. What are the pluses and minuses of these two strategies? How has the dramatic drop in the value of the Aussie dollar affected the costs at Duloc? Will the fall in the Aussie dollar have any positive effects on the profits of wineries in the Southern Vales? Use a firm/market diagram to explain why Zoë thinks that Duloc should move into the “grey wine market. How will this market be affected if other wineries produce “grey wine”?

Review the law of supply and apply it to this question. Review the concept and apply it to this question using general examples of all non-price determinants of supply. Review again the concept and apply it to this question. Draw the market model and then shift the supply curve and explain the shift using specific examples from as many non-price determinants of supply as you can think of. Review the relationship between price elasticity of demand and total revenue for agricultural products. A bumper harvest is an unusually large harvest often as a result of optimal growing conditions. Review/paraphrase the concept from the textbook and illustrate it with some examples. This is a business decision, you need to think about the long-run the short-run price elasticity of demand and income elasticity of demand. You also need to think about costs. Use a market/firm diagram to analyse this question. Use a market/firm diagram to analyse this question. Use a market/firm diagram to analyse this question. Think about why the demand for grey wine increased in the first place, recall the recession in Australia from 1990 to 1993. This is a short run analysis. Use a market/firm diagram to analyse this question. This is the long run part of question 9. When will this process stop?

Topic 4

Week 5

Demand
Wine Demand Hits Prices
Canberra -- OVERSEAS buyers cannot get enough of Australian wines but while the high demand is a boon for local wineries, it also means soaring prices for wine lovers back home.

Retailers report price rises up to 200 per cent for some premium red wines and increases of 25 per cent for cheaper wines because vineyards cannot grow enough grapes in the short term to fill the demand.

According to an Australian Bureau of Statistics report released yesterday, 1996-97 was a record year for Australian wine exports, with 154 million litres worth more than $603 million sold around the world.

Britain was the biggest importer, buying 73 million litres valued at $262 million. It was followed by the United States with 22.5 million litres worth $119 million and New Zealand with 16.4 million litres worth $40 million.

South Australia continued to be Australia's biggest exporting State, selling 114 million litres overseas. WA winemakers contributed 842,000 litres - up from 596,000 litres the previous year.

Domestic sales of local wines were also up - to a record 336 million litres. White wine continued to dominate - selling 185 million litres - but red wine made strong inroads with bottle sales up 114 per cent to a total of 79 million litres.

Australians still prefer to drink wine from a cask - 168 million litres compared to 96 million litres sold in bottles.

The average consumption of wine for Australians aged over 18 years was about 18 litres each in 1996-97, compared to 94 litres of beer.

Annie Jens, from Vintner wholesalers, said Australians were paying more for wine because demand exceeded supply.

"Our export push has been so successful that the really good quality wine and also the lower end of the market have been going overseas in big quantities," she said.

High prices would continue for the next few years until about 8000 ha of vines - planted around the country to help cope with the big demand -bear fruit.

Mrs Jens said chardonnay and sauvignon blanc was more readily available than many of the reds. Australian shiraz in particular was in big demand overseas.

"Ten years ago people were pulling the (shiraz) vines out - when chardonnay became the drink of the moment shiraz fell off the face of the earth," Mrs Jens said. "Now they have come back with a huge push and it is a much sought after because the variety is peculiar to Australia."

John Jens, from John Coppin wine merchants, said he had seen an amazing growth in prices, especially for premium red wines. Many wines which retailed at $30 three years ago now sold at $110.

It was difficult for suppliers to get enough stock to sell because much of it was going overseas.

"People traditionally buy whites to drink that week but people buy reds for drinking and to put down (cellar) as well and that is putting pressure on the market," he said.

The West Australian 24 December 1997

It is now late-1997 and the bad years of the mid-1980s are all but a distant memory to the grape growers and wine makers of the Southern Vales. The strong recovery in grape prices has been brought about by increased demand of Australian wines overseas, particularly in the UK and the USA. This growth in exports has spawned an amazing surge in investment in the Southern Vales. New vineyards are being planted all over the valley. The relatively small farms in the Southern Vales, and the consequent small sized fields, is making it increasingly uneconomic to grow cereal and other broad acre crops in the region. Cereal growers in particular simply cannot gain the economies of scale that are required to remain competitive in a context of increasing input costs and falling world prices for agricultural commodities. The average farm in the Southern Vales produces about two tonnes of wheat per acre and the price of wheat seems to be stuck at USD $125, or AUD $150, per tonne, while costs just seem to keep rising. Hence, many farms that previously grew wheat and other broad acre crops are being turned over to grape production.

The grapes that are being planted are mostly traditional red varieties, such as Shiraz, Cabernet Sauvignon and Pinot Noir. However, new varieties, at least to the Southern Vales, such as Malbec, Merlot, Cabernet Franc, are also gaining popularity. The Southern Vales is a rain fed and not an irrigated wine growing region. Consequently, vineyards produce between five and eight tonnes per acre, depending on the year’s rainfall. This is substantially less that the yields that are obtained in irrigated regions, such as the Riverland where ten tonnes per acre plus is the norm. Hence, there is a growing a ground swell of pressure in the Southern Vales to use water from the Christies Beach Sewerage Treatment Plant to irrigate the Southern Vales.
This investment in grape production is coming from three quite distinct sources. Firstly, a number of the large wineries in the region are buying uneconomical cereal farms, consolidating the paddocks and planting vineyards. Second, established grape growers are buying neighbouring properties and expanding their grape planting. Finally, some of the larger farms that were involved in the vine-pull scheme of the mid-1980s have re-planted their former vineyards. However, these farmers seem to have learned the lessons of the past.
The growth in the wine industry in the Southern Vales has occurred in response to two distinct processes. First, the national/multinational firms that dominate the Australian market have expanded their operations. However, there has also been an explosion in small boutique wineries.
There have also been some amazing developments at Duloc over the past few years. Matthew got married in 1995 to Angelique and their first child, Georgia, was born in 1997. Matthew and Angelique now live in the Barnes family home at Duloc. Zoë has moved to Flinders University and has been promoted to associate professor and has bought a house in Reynella. Matthew is still employed by CSM-Harry’s at Reynella, but he just seems to be going through the motions. The operations at Duloc and the demands of his young family seem to be the focus of his energies. With the recovery in grape prices Matthew and Zoë, like many other mixed farmers in the region have also increased their planting of vines. This decision at Duloc was driven by two factors, new techniques that have substantially reduced the cost of planting vines and the increased opportunity costs associated with the land not being planted to grapes. Leading in turn to higher land prices and higher land rents/lease prices. However, despite the substantial increase in vine plantings, only about half of Duloc is planted to grapes due to the capital constraints faced by Matthew and Zoë.
At Zoë’s insistence, Matthew has tended to follow the trends in the region and has planted large areas of those red varieties that have become popular in the region. However, he has also expanded his plantings of formerly popular white grape varieties, such as Riesling and Chardonnay. But he has also planted substantial areas of unusual and uncommon white grape varieties.
It is becoming increasingly apparent to Zoë that James indeed did not do anything by halves. Although the wine making facilities that Matthew’s father installed are more than a little out-dated, they work well and Matthew can use them to produce very good quality wines. Moreover, this equipment can easily accommodate the quantity of grapes that are currently being produced by the 160 acres of vines that have already been planted at Duloc. Indeed, these facilities could easily accommodate the total production if all 320 acres of Duloc were planted to grapes. In fact Zoë and Matthew are still unsure exactly how much wine these facilities can produce. The answer to these questions will be learning by doing. James bought these wine making facilities from Harry’s in the late-1970 for scrap when Harry’s installed new equipment. He then subsequently re-assembled some of this equipment at Duloc. Nevertheless, Matthew continues to see his wine making operations at Duloc as a hobby, as way a of developing his wine making skills that are not being used by his current employer and as a way of fuelling his passion for wine. Hence, the vast majority of the grapes produced at Duloc are still being sold on the trailer trade or under contract to larger wineries.
Matthew’s reputation as wine maker has been growing since his decision to start producing wine at Duloc. However, this has not been recognised by his employer. Wines produced under the Duloc brand consistently win gold medals at important wine shows and he was even shortlisted for the very prestigious Jimmy Watson Trophy in 1996.


Topic 4

Week 5

Demand

Questions

Hints

Explain the law of demand and explain why the demand curve slopes downwards. Explain the difference between a change in demand and a change in the quantity demanded, illustrate your answer with diagrams. Outline the determinants of demand and then explain why grape prices have risen recently. Ignore any supply side factors at this stage. Illustrate your answer with a firm/market diagram. What does the term economies of scale mean and how are they attained in wine production, illustrate your answer with a diagram. What does the term economies of scope mean and how are they achieved in the wine industry? Why are land prices in the region rising? Why is this making it more difficult for Matthew and Zoë to lease the land on which they do not grow grapes? How should Zoë and Matthew respond to increased land prices? Explain your answer. How should Matthew and Zoë respond to the demand side factors that are mentioned in the article? The demand for red wines is growing strongly, so why is Matthew planting white wine varieties? The article on page 1 refers to the “minimum pricing structure”. This was a price floor, set above the equilibrium price. What problem was it designed to solve? Did it solve the problem? What would have been a better solution?

Review the law of demand and apply it to this question. Review the concept and apply it to this question using general examples of all non-price determinants of demand. Review again the concept and apply it to this question. Review the concept and apply it to this question Review the concept and apply it to this question This question is related to derived demand and opportunity costs, but restrict your answer to derived demand. Remember, the Southern Vales has a boundary, so the total amount of land to buy and sell and land to lease is fixed. That is, what should Matthew and Zoë do with the 240 acres of farm that they own that are not yet planted to grapes? This is an opportunity to apply the guiding function of prices. Briefly outline the demand side factors that are discussed in the article and then explain what you would do in this situation. Boom-bust cycles are common in agriculture when there is a long time between planting and harvesting. Model both the long-run and the short-run situations before you answer this question. Explain the difference between the short-run and the long-run scenarios.

Topic 5

Week 6

Elasticity

Tax increase to push up wine prices By NIGEL AUSTIN Advertiser 25 March 1999 THE State's wine industry is gearing up for a fight against an increase in wine tax. Australia's distilled spirits industry has launched a campaign for tax reform aimed at ensuring all alcoholic drinks are taxed at a uniform rate based on alcoholic content. This would ensure that the tax on wine, currently 42 per cent, would be increased to match the higher rates paid on beer (91 per cent) and spirits (253 per cent). The Premier, Mr Olsen, said yesterday he had written to the Prime Minister, Mr Howard, and the Treasurer, Mr Costello, calling for the wine industry to be spared any tax slug as a result of tax reform. "Don't tax it into submission and don't tax it out of further growth," he said. Changes to the system would lead to a loss of investment and jobs. Mr Olsen said the Centre for Economic Studies was preparing a report for the Government and the SA wine industry. The study would be used to argue the State's case to the Federal Government when it unveiled its tax reform package. The chairman of the Distilled Spirits Industry Council of Australia, Mr John Livingstone, has branded Australia's alcohol taxation regime as "a mish-mash of a system needing drastic overhaul". In the latest issue of the council's newsletter, he says a bottle of scotch delivering 22 standard drinks has a tax take of $16 a bottle while a wine cask with 38 standard drinks has a tax take of $2.50 a glass. He calls for the Federal Government to move to a system of taxing alcohol based on alcohol content by volume.

It is now late-1999 and the wine industry in the Southern Vales just seems to be going from strength to strength. The industry is further consolidating its position as South Australia’s premium wine producing region as a consequence of the continued strong growth in export demand for red wine, especially to the UK and USA, and the consequent higher grape prices in underpinning the continued expansion of the wine industry, both nationally and in this small wine producing region. New vineyards just seem to be popping up all over the place, especially given that low wheat prices and rising costs of wheat production are forcing more and more farmers out of broad acre cropping in the Southern Vales. Interestingly, the number of wineries, both big and small, seems to have stabilised over the past few years. There have been no new entrants to the region since 1986. However, existing firms seem to be focussing on increased production.

On the other hand, the situation at Duloc seems to be coming to a head. CSM-Harry’s has been bought by a French champagne house to form CDM-Harry’s-Noet. The strategic direction of the company now seems to be following the French tradition of individual wine producing areas focusing on one variety of grape production and consequently one variety of wine. In this situation the production of soft red wines. This stands in stark contrast to the Australian tradition. Australian grape growing regions may specialise on one grape variety, for example the Barossa Valley is world famous for its Rhine Riesling, but they grow many different varieties and hence produce many different wine types. Hence, the company is restructuring its grape growing operations and removing grape varieties that do not fit with this new strategic direction. Moreover, Matthew has been forced further down the food chain, with no opportunity to exercise his wine making skills. This is despite the fact that a wine he produced at Duloc won last year’s Jimmy Watson Trophy. Moreover, he is being forced to produce light fruity reds that are ready to drink now. These wine varieties are popular on the east coast and are the varieties on which the Hunter Valley built its reputation as a wine producing region. However, Matthew wants to make the full bodied, bold red wines on which the reputation of the Southern Vales was built.
As a consequence of the changed strategic direction of CMD-Harry’s-Noet, Matthew has resigned and he and Zoë have decided to turn Duloc into a fully commercial wine making business. Zoë and Matthew have taken advantage of the booming real estate market and have mortgaged their houses in order to plant the remaining area of Duloc to grapes. At present the 80 acres of grapes that have been planted at Duloc produce about 400 tonnes of grapes per year. These grapes are then used to produce about 280,000 litres of wine. However, they have a key decision to make. Should Duloc focus on producing bulk wines that are readily sold to nearby wineries for blending or cask wine production. These wines are cheap and easy to make and are easy to sell in the current buoyant market, given Matthew’s reputation. Or should Matthew and Zoë focus on producing commercial qualities of premium wine and hence invest heavily in building a new brand in a market that seems to be increasingly congested in terms of the recent proliferation of new brands and boutique wineries nationally.
On 1 July 2000 the Howard Government introduced the Goods and Services Tax (GST) and the Wine Equalisation Tax (WET). The GST is a 10 per cent tax on most goods and services and was designed to broaden the Australian tax base by taxing services, which had not been taxed before. The WET was designed to increase the level of taxation on wine so that the tax per unit of alcohol on wine, beer and spirits were roughly the same. The WET is a 29 per cent tax on the wholesale price of wine which is about half the retail price. The WET also replaced the 22.5 per cent wholesale sales tax on wine.

Topic 5

Week 6

Elasticity

Questions

Hints

Why have no new wineries entered the market between 1985 and 1996 despite increasing prices for both grapes and wines? Illustrate your answer with a firm/market diagram. How is it possible that wine production in the Southern Vales has increased even though there have been no new entrants? If Matthew and Zoë produce bulk wines what market structure will they operate in and what will be the price elasticity of demand for their production? If Matthew and Zoë produce ultra and super premium quality wines what market structure will they? Reflect on your answers to questions 3 and 4. What strategy would you employ, explain your answer? Illustrate with appropriate diagrams. Estimate the PED and the IED of demand for all five market segments discussed in the Introduction. Which market segment(s) should Matthew and Zoë foCus on? Why are wine producers in the Southern Vales so concerned about the introduction of the GST and the WET, whereas wineries in the Riverland were not so concerned? Why are the current tax rates on spirits (253 per cent) and beer (91 per cent) so much higher than the rate on wine (42 per cent)? Explain your answer Notwithstanding the increased fixed costs associated with increasing the area of vines planted at Duloc, what will happen to the profits at Duloc as a result of increasing vine production? Suppose now that the Government thinks that grape prices are too low. So, it decides to introduce a binding price floor. What would be the short-run and the long-run effects of such a policy? What would be a more effective policy to address the problems associated with low grape prices?

Review the conditions that lead to entry and exit in markets. Reflect on the profits that firms were making in the late-1980s and early-1990s and show these on a firm/market diagram. Note even though no new wineries opened during this period the quantity of wine produced did in fact increase, explain this paradox. This may be a trick question. Assume that these firms are, perfectly competitive. Usually firms in perfect competition are operating at the bottom of their ATC, but this may not be the case here. Use a firm/market diagram as the basis for your analysis. Look at the relationship between price and marginal cost. You should start with price being about the level of Min AVC. Review and apply the theory relating to market structures. Review and apply the theory relating to market structures. Think about what type of market structure is best for this type of firm. Draw the firm market diagram for this market structure. Remember, the key factor in PED is the number and closeness of substitutes. The Southern Vales is a premium wine producing region, whereas the Riverland is not. This has implications for PED. Illustrate the effects of these two taxes with an industry diagram for both the Southern Vales and the Riverland. Determine the price elasticity of demand for beer, wine and spirits. Again think about the availability and closeness of substitutes. Draw a set of cost curves for Duloc, ignore the increase in fixed costs and assume that Duloc operates in a perfectly competitive market. Bear in mind that Duloc has substantial excess capacity. Assume that Duloc is a perfectly competitive firm for ease of analysis. Model the short-run and long-run effects of a binding price floor.

Topic 6

Week 7

Markets in action

Grapes go down the drain - enough to make 2750 bottles of premium wine.
Leisha Petrys.
Sunday Mail 9 June 2002
About 3,500 tonnes of grapes will be left on the ground in South Australia's Riverland region because of a lack of buyers. An unusually mild summer helped the region produce a record yield of 360,000 tonnes of grapes in 2002, a 10 per cent increase on 2001. Riverland Wine Grape Growers Association chairman Malcolm Hill said a big increase in plantings since 1997, and the collapse of a local winery, had exacerbated the region's over-supply of grapes. South Australian Wine & Brandy Association president Vic Patrick said the nationwide grape surplus was only three per cent, which he did not see as an issue.

About 3,500 tonnes of grapes will be left on the ground in South Australia's Riverland region because of a lack of buyers. An unusually mild summer helped the region produce a record yield of 360,000 tonnes of grapes in 2002, a 10 per cent increase on 2001. Riverland Wine Grape Growers Association chairman Malcolm Hill said a big increase in plantings since 1997, and the collapse of a local winery, had exacerbated the region's over-supply of grapes. South Australian Wine & Brandy Association president Vic Patrick said the nationwide grape surplus was only three per cent, which he did not see as an issue.

Taste of the grape to come from famous user of hops.
By MEREDITH BOOTH
Adelaide Advertiser 25 September 2002
CARE for a glass of Coopers chardonnay? Adelaide's Coopers Brewery is considering adopting its own wine label. The company, best known for its sparkling and pale ales, was passively eyeing potential wine opportunities, executive chairman Glenn Cooper said.

He said the family-owned brewer had "always taken things carefully" and the addition of actual wine to the range could take two years. "If we were to go into the wine area, it would definitely be at a premium top-image end," Mr Cooper said. "We would look to market that along the same lines that we market pale and sparkling ales."

Mr Cooper said any potential wine brand would need already to have established a strong image as a premium product. Coopers already is selling premium home-winemaking kits in Canada and has a small market for the kits in Australia.

Meanwhile, sales of Coopers pale ale have jumped 26 per cent this financial year but Mr Cooper said there was no underlying reason why.

The ale's popularity had increased in regional South Australia, Darwin, Victoria and New South Wales - up between 26 and 30 per cent on the previous July and August.

"There was a huge increase in people outside of Adelaide, with country areas now putting it on tap," Mr Cooper said.

Volumes in Victoria were likely to climb from two million litres to three million litres this financial year while Sydney drinkers had recorded a 30 per cent increase so far this year, from four million litres sold last financial year. Sales of Coopers draught were "okay", Coopers light sales were under pressure from Cascade and Hahn light brews and pale ale sales had taken about 1.5 per cent from sparkling ale volume sales, he said.

It is now early-2002 and the Southern Vales are still reeling from the effects of last summer. The growth in export demand, especially for red wine, has slowed substantially and the mild summer led to a bumper harvest. Production was up by about ten per cent right across all of the State’s grape growing regions. Moreover, the Southern Vales was no exception. The slow growth in demand and the increase in supply led to a decrease in the price of grapes. Areas, that specialise in high volume, low quality grape varieties that are intended for bulk wine production and the wine cask market, such as the Riverland, were hit the hardest, with many growers not even bothering to harvest their grapes. This is because the wineries who usually buy these grapes were able to buy large quantities of better quality grapes at ridiculously low prices. In premium wine growing areas such as the Southern Vales, growers were able sell all of their grapes, but at much reduced prices.

Duloc has also been affected by the bumper harvest. Total grape production at Duloc actually rose by a little over 20 per cent this year through a combination of the good weather and the extensive plantings of the late-1990s maturing. Indeed, Matthew expects that grape production at Duloc will continue to increase by about five to seven per cent per annum for the next for the next few as those vines continue to mature.
Over the past decade or so, Matthew has been experimenting with different wine styles, different grape varieties and has been further developing his wine making skills. As a result, Duloc now produces a comprehensive range of wines, from the lightest fruitiest whites to the biggest, boldest reds. He also produces a few sparkling varieties and a couple of nice ports. The growing range of styles means that wine production has kept up with the increased grape production, but that the amount produced of each variety remains limited and hence keeps prices up. However, Zoë the concept and apply it to this question is concerned that the projected increase in grape production means that he will need to increase the amount of each style he makes and that this will lead to lower prices and hence lower profits.
The traditional response to an increase production is storage, either of grape juice, bulk wine or bottled wine. But the increased grape production over the past few years means that Duloc’s no longer has any excess storage capacity. Moreover, given the supply conditions across the vales, extra storage capacity will be expensive to build and it is not going to happen soon. Zoë has two other suggestions, in the short-run, Matthew could produce a range of “clear skins”. The clear skins market is rapidly growing and Matthew should have no problems selling his “clean skins” to a South Australian based distributor. However, Matthew is appalled at the suggestion of selling a $30 bottle of wine for less than $10, just because it does not have a label on it. Zoë’s second suggestion is that Matthew could use his excess grapes to produce grape spirit, that is, to distil excess wine to produce pure ethanol, to use in his ports and maybe even make brandy. But this option will require an investment of about $20,000 to build a still and to construct a bond store, but it may take some time to obtain the required certification from the Excise Branch of the Commonwealth Department of Customs.

Note:
Cleanskin wine is a term for bottled wine that does not carry a label or any other identifying marks as to who produced the wine. Cleanskin wines have been sold in Australia since at least the early-1960s, but are generally only popular during periods of imbalance in the Australian domestic wine market, i.e. when the quantity supplied exceeds the quantity demanded. Wineries will sell cleanskins to dump excess or unwanted wine stocks and do so to avoid the negative consequences of discounting their existing brands. This form of dumping often has very little to do with the quality of the wine and consumers can benefit greatly however there is always an element of risk when purchasing cleanskins.

Topic 6

Week 7

Markets in action

Questions

Hints

How did the climatic conditions that are discussed in the article affect the market for grapes? Illustrate with a firm/market diagram. How did the market for grapes affect the market for wine? Why were grape producers in the Southern Vales concerned about the introduction of the GST and the WET? Why did growers in the Riverland decide not to harvest their grapes, illustrate with a market/firm diagram? What market structure is Duloc operating in? Illustrate your answer with a market/firm model. What form does competition take in this market structure/these market structures, provide some examples? What happens to the demand curve at Duloc whenever a new winery enters the market. How should Matthew and Zoë respond when new firms enter the market? How would Duloc respond to the entry of a new firm it was a perfectly competitive firm. Illustrate your answer with appropriate diagrams. Should Matthew be worried about downward pressures on wine prices? What do you think about Zoë’s idea of selling excess production as cleanskins?

Review and apply the law of supply. Review and apply the law of supply. Illustrate with two sets of firm or firm/market diagrams, be sure to estimate the relative elasticities of Demand and supply. Think in terms of derived demand and who bears the burden of taxation. Draw a firm market diagram and use it as an analytical framework. Bear in mind the relationship between price, AVC and MC. Is the whole of a firm’s MC curve its supply curve? Draw a firm/market diagram of a representative firm making profits, losses or operating at short-run equilibrium. This may be a trick question, Duloc may now be operating in more than one market/industry. Outline ways that firms in this market structure compete with each other to maximise profits. This question is about the market structure that Duloc sees itself operating in. Model the changed market conditions, i.e. the effect on P and Q, and then think about how the firm will respond. Note, the answer to this question depends on the answer to Question 5. You need to use and manipulate a firm/market diagram in order to answer this question. Discuss the impact of entry on Duloc and how it should respond to restore profits. Given the market structure that you think Duloc operates in, explore the options that are available to Zoë and Matthew to increase profits. This question is about third order price discrimination, compare the profits earned by a single price monopolist and a price discriminating monopolist. Assume only two market segments and illustrate with a yacht diagram.