Australia’s known to produce the best wool in the world; hence it has dominance in the worlds market of Merino wool of 50% and greasy wool of 27% as of June 2001 (ABS, 2007). In the early 1970’s to stabilise the declining price of wool, the Australian Wool Council (AWC) implemented a minimum price floor scheme to protect the Australian wool producers. The price floor for wool began in 1974 and ended in 1991 as “there was no plan to cope with the sharp reversal in the supply-demand situation.” (Clancy, The reason wool was knocked to the floor, 2011).
1.2 Price floor
Price floor refers to the minimum price level in which a commodity can be sold in the market (Hubbard, ...view middle of the document...
As the demand for Australian wool decreased in the international wool market, the market moved from being a consumer surplus market to a producer surplus market. The price floor prevented the market from being in an equilibrium position hence a reduction in economic surplus creating a deadweight loss.
1.3 Downside of price floor
The primary concern with regard to a price floor is that it is an artificial price imposed on the market to influence the behaviour of market participants (Hanley, 1993). However, it is difficult to predict how the market would react to the imposition of a price floor. For example, the buyers may see the move as unattractive and totally abandon the market, especially in an industry where alternatives are available (Oczkowski, ND). For example, the wool importers had the option of purchasing wool from other wool producing nations such as China, Russia or New Zealand, when they found the Australian wool market unattractive. (Australian Wool Innovation Limited, 2012), which then weakens the surplus as demand of Australian wool decreases further.
On the other hand, the biggest challenge faced by regulators when imposing price floor is arriving at an appropriate floor price. The impact of setting a floor price that is not accepted by the market is particularly evident in the Australian wool market. As illustrated by Clancy, B. (2011), in the initial stages when the floor price was low, the wool production increased in Australia and wool exports gradually increased. It was beneficial to the farmers and wool exporters in the country.
However, in 1987 the regulators got carried away by the benefits of price floor and significantly increased the floor price of wool further (Clancy, History of wool's reserve price, 2011). Although it encouraged sheep farmers to expand their operations, it made Australian wool expensive in the international wool market. Therefore, international wool importers turned their backs on Australia and moved towards other wool exporting countries. As a result, from 1988 wool exports started reducing, the surplus worsens.
The collective behaviour of market participants can only be evaluated over a long period of time (Oczkowski, ND). Therefore, if the imposition of price floor turns out to be a failure, it is difficult to rectify its impact on the market. In Australia, when wool exports started declining following the imposition of a very high floor price, the regulators realised their mistake and reduced the price floor. However, they couldn’t prevent the decline of wool exports.
When a price floor is set to a particular commodity, the government is forced to purchase any additional quantity produced and not consumed by the market at the floor price. Some economists see this as inefficient usage of taxpayer money. Other repercussions that resulted from the implementation of price floor include farmers becoming too confident in the market hence over investing (ABS, 2007), unemployment rose...