The Impact of the Guaranteed Price Policy on the European Sugar Market
Sugar industry is one of the most dynamic in the structure of the food industry and plays a significant role in the economies of several countries. The European Union leads the five largest importers of sugar. Sugar production in the EU is expected to grow by 10% in the 2017/18 season. The production may reach 18.3 million tons, but still will be lower than the record 2014/15 season (19.4 million tons). Sugar production growth is expected in France (up to 5.5 million tons) and the UK (up to 1.4 million tons). However, despite the increase in production, the EU will remain a net importer of sugar. The main reason is the low stocks of sugar in the EU. To meet the demand, it will be necessary to import about 3 million tons of sugar (Commodity Basis, 2015).
In the market economy, the price is influenced by various factors, and these factors act at different power in different directions and at different times. It is almost impossible to take into account the effect of all the factors, therefore, to determine exactly what the market price for a particular product will be is very difficult. Only indicative (base) price for the products can be defined (Varian, 2009).
The direct regulation of prices by the state can be carried out through the use of guaranteed prices for agricultural products purchased for public use. They are set at the federal and regional levels. Guaranteed prices are introduced to protect the producers from the loss in circumstances, where the market prices of products stably do not compensate objectively folding production costs, and to provide them with a guaranteed sales channel in the event of adverse market conditions (Mankiw, 2014).
Guaranteed price policy is one of the measures to ensure price stability in the sugar market. In this case, the EU guaranteed to pay sugar producers a price of 632 euros per ton despite the quantity produced. This implied that if the market price for sugar fell below the 632 euros, the EU sugar policy would dictate that the sugar companies sold their sugar at 632 euros per ton (BBC News, 2005). However, if the equilibrium price rises above the guaranteed price, the market price prevails (Mankiw, 2014).
Guaranteed price leads to the over-production of sugar in the market. In a freely operating market, an introduction of a price control measure such as price floor or price ceiling will affect the supply and demand. If the price set over the equilibrium price, quantity supplied will increase while demand will fall causing a disequilibrium in the market. If market forces operate freely, the increase in supply and the decline in quantity demanded will lead to a fall in equilibrium price (Mankiw, 2014). Under a guaranteed price situation, the market will be in equilibrium when the guaranteed price is lower or equal to the market price. In this case, the market price will prevail, and the sugar companies in the Eurozone will produce the equilibrium quantity as shown below.
Agricultural products and products of its processing are sold in a non-elastic and even completely inelastic demand. This is because the food is a necessity, and hence, the population will buy it even at the increased price, while reducing the purchase of the goods with industrial origin (Varian, 2009).
Disequilibrium in the market arises when the guaranteed price exceeds the market price. Since the sugar companies are assured of selling their products at the guaranteed price, they will produce more to maximize their earnings. Thus, there will be over-production in the market for sugar. Therefore, there will be an excess of supply over demand for sugar. The disequilibrium will continue even in the long-run (Mankiw, 2014).
As shown in the graph below, sugar companies will produce Q0 and charge P0 if there is no guaranteed price. With the guaranteed price GP, above the market price, total production will increase from Q0 to Q1. The price will fall to P1, but sugar firms will still earn the GP price, hence they can continue over-producing in the long-run. The guaranteed price policy was assisted by the EU’s prohibitive import tariffs. The tariffs ensured that consumers in the EU market limited access to the world sugar market. Sugar production increased but sugar prices are still far higher than the world price. This prompted many in the industry to call for the abolishment of these tariffs. The European Commission announced in June that sugar quotas will be abolished by 2017.
Figure 1. Supply and Demand of Sugar
Winners and Losers of Guaranteed Price Policy
The guaranteed price policy affects different participants in the market differently.
Consumers. With the price of PS the volume of consumer demand falls to Q1, but the value of supply increases to Q2. To support this price and avoid the accumulation of stocks in the warehouses of manufacturers, the government is forced to buy products in the amount Qg = Q2 – Q1. In essence, the government adds its demand Qg to the demand of consumers, and producers can sell all the produced volume at price of PS (Varian, 2009).
Consumers, who continue to buy goods, have to pay a higher price PS instead of the price P0, so that they have a loss from the loss of consumer surplus represented by a rectangle A. Due to the high price, the other consumers no longer buy goods or buy them in smaller quantities, and their excessive losses are represented by a rectangle B. As in the case with the lowest price, consumers lose an amount equal to CS = – A – B (Varian, 2009).
Manufacturers. On the other hand, producers are in a prize (for their sake such a policy is hold). Now, they sell greater amount Q2 instead of the amount of quantity Q1, and at a higher price PS. Figure 2 shows that the producer surplus increases by the amount of CS = A + B + D (Varian, 2009).
Government. At the same time, the government faces with the costs (which are covered by the tax and thus are ultimately the costs to the consumer). These costs are equal (Q2 – Q1)*PS – this is the amount the state must pay for the volume of the issue, which it purchases. On Figure 2, it is a big rectangle spotted. The government can reduce the cost, if it could “get rid” of some of its purchases, i.e. to sell them abroad at a low price. However, in doing so, it prevents domestic producers to sell their goods in foreign markets, which is what the government is trying to cater to manufacturers in the first place (Varian, 2009).
Figure 2. The Effects of Guaranteed Price on Producers, Consumers and Government
Thus, the European sugar producers are the biggest winners. Producers can charge a price higher than the equilibrium market price and still sell the same quantity they would sell at market equilibrium. Other winners of this guaranteed price are sugarcane farmers, employees and other providers of factors of production. The ability of sugar producers to pay better prices for their factors of production depends on the price of the final product (Sexton, 2015). If a producer gets a higher price for its products, it can afford better prices to its suppliers of raw materials, its workers and other sources of factors of production. The guaranteed price exceeds the world price for sugar per ton by three times (BBC News, 2005). This implies that sugarcane farmers earn higher prices for the sugarcane supplied to the sugar producers. Besides, the employees of the sugar companies benefit from better salaries. The guaranteed price also enhances the profitability of the sugar companies. Thus, the shareholders of companies also benefit from higher returns on equity or investment in the companies.
As shown above, the guaranteed price policy affects both consumers and producers differently. The rice is far above the equilibrium price hence producers benefit from increased profit margins. Producer surplus increases and this also benefits sugarcane farmers, employees at the sugar factories and investors in sugar companies. However, consumers lose since they have to pay higher prices to buy sugar. Consumer surplus declines as shown above, lowering the welfare of consumers. Therefore, the government and other economic policy makers must consider both effects and create a balance between the conflicting effects and ensure there is a net gain for the entire economy. To implement this policy, the government should accompany it with a price subsidy to the consumers.
The Impact of Cut Price
The European Commission’s decision to reduce subsidies for white sugar and sugar beets will shake up the European as well as the global market for sugar. Subsidies are important since they reduce the cost of production for the producers (Husted and Melvin, 2007). A price subsidy affects players in the market differently.
Effect on UK Sugar producers
The cut in subsidies will affect UK sugar producers adversely. It will lead to an increase in the cost of production for UK sugar producers. If the price of sugar in the UK market remains constant, UK sugar producers will suffer a decline in the profit per tonne (Husted and Melvin, 2007). The rise in the cost of production will also lead to a decline in the quantity of output. Producers produce at a quantity that equates the marginal cost and the marginal revenue. If the marginal cost increases but the marginal revenue remains constant, the firms have to cut back on their production to reduce marginal cost and total cost. The decline in production will cause to an inward shift in the supply curve. This further reduces producer surplus and profitability of the UK sugar producer.
The extent of the loss to the UK sugar producers will depend on the price elasticity of demand for sugar. If the demand is price inelastic, producers can shift the burden of the additional cost to the consumers through a price increase hence the cut in subsidy will not have a significant effect on their profitability (Husted and Melvin, 2007). If the demand is price elastic, the producers will lose since they cannot pass the burden of increased production cost to the consumers.
UK consumers
Consumers will also have a share of the adverse effects of the cut in subsidies. Subsidies benefit consumers through reduced prices of commodities. Producers can shift the burden of increased production cost to the consumers. This can be done naturally by influencing the quantity supplied. Subsidies helped the sugar companies lower their production costs thus enabling them to produce larger quantities of sugar and sell at lower prices. The increase in the cost of production will cause an inward shift in the supply curve for sugar as shown in the diagram below. Since the demand for sugar will remain relatively constant, the shift in the supply curve will cause an increase in the equilibrium price for sugar as shown below (Cherunilam, 2008). The price increase will negatively affect consumers as it will reduce consumer surplus. Consumers will have to pay more for sugar than they pay with the current rates of subsidies.
World sugar prices
A cut in subsidies to European sugar producers affects global sugar prices. The reduction in subsidies will increase the cost of production for the UK producers. This will increase the marginal cost of producing sugar and force the sugar producers to cut back on their production quantities. The price of sugar in the world market is determined by the supply and demand for sugar. The global supply of sugar is dependent on the supply of individual countries producing sugar. A reduction in the production of sugar by the UK producers will lead to fall in the global sugar supply (Cherunilam, 2008). Thus, the result will be an increase in the global price of sugar.
Trade Creation and Trade Diversion
The establishment of a common market leads to trade creation and trade diversion. The members of a common market liberalize their markets and eliminate any barriers to the international trade among them. If a European common market is established, it will affect the UK economy through both trade creation and trade diversion. The UK initially imposed tariffs and other barriers on trading with other countries. The elimination of such tariffs will reduce the prices of goods and services from other countries (Carbaugh, 2008).
In this case, the UK market has sugar produced domestically and imported sugar from countries within Europe and around the world. Before the establishment of the common market, the UK domestic sugar was less expensive compared to sugar from other countries. When the common market was formed, tariffs and customs on sugar from other countries within the common market were removed (Carbaugh, 2008). This lowered the prices of sugar from those countries. As the law of demand suggests, the decline in prices led to an increase in the demand for sugar in the UK market. The increased demand created more opportunities for sugar producers within the common market thereby resulting in trade creation as shown below.
Figure 3. Trade Creation
As shown above, the removal of the tariff to a member of the common market leads to the trade creation. Without any foreign trade, the equilibrium price for sugar in the UK market is P1, and the corresponding quantity is Q1. The foreign supply (from Denmark) of sugar before the elimination of tariffs across the common market is FST. The price falls from P1 to P2 and the equilibrium quantity increases from Q1 to Q2. When the tariffs on sugar supply from Denmark are eliminated for the common market member, it will supply more, and the supply curve will shift from FST to FSWT. As shown above, the price will fall to P3 while the quantity demanded will increase to Q3. The biggest winners will be the consumers. The consumer surplus will increase by the areas marked A. B, C and D. However, the UK sugar producers will lose. As shown above, the common market introduction will cause a decline in sugar prices (Carbaugh, 2008). The demand for the UK sugar will fall from Q1 to Q4 hence producer surplus will decline by the areas market A and B.
The establishment of the common market will also affect countries that are not members of the common market but initially traded with the UK. New tariffs will be imposed on such countries thus making their products more expensive (Carbaugh, 2008). The UK consumers will not use the sugar from a country outside the common market since it will be more expensive.
As shown in the diagram below, the UK trade with the USA is more efficient than trade with Denmark. Sugar from the US has a lower price than that from Denmark. After the introduction of the tariffs to non-EU members, the sugar from the US becomes more expensive hence its supply curve shifts from USA FSWT to US FST. This causes a decline in the quantity of the US sugar demanded from Q3 to Q1. Thus, it results in a shift from trading with a more efficient USA to a less efficient Denmark. This scenario is called trade diversion (Carbaugh, 2008).
Figure 4. Trade Diversion
The above scenario illustrates that the trade restriction may not be beneficial. As part of the 2006 sugar reform program, the EU retained its import quota, but encouraged its members to abandon the production quota to reduce production and avoid large surpluses. The sugar reforms in the EU have led to a decline in sugar exports from 7.5 million tonnes to just 815,000 tonnes.
The Main Issues Facing the British and World Sugar Sectors Over the Next Few Years
The situation in the international sugar market has changed significantly in recent years. Sugar is strategically important commodity and preservation of the independence of own country’s market is a priority factor. An important trend is the increase in the global production and consumption (Sexton, 2015).
The European sugar beet processors will face competition from processors in the Middle East and North Africa regions, which have been the main market for Europeans up to the introduction of export restrictions. More profitable beet growers, who will be able to increase the scale of production to produce sugar at competitive prices, will benefit from these changes. However, the uncompetitive sugar-beet growers with higher costs, particularly in southern Europe, can be pushed out of the market. The cancel by Brussels of isoglucose production quotas (also known as fructose syrup) will also lead to the increased competition in the European market and the subsequent consolidation.
References
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Carbaugh, R. (2008). International economics. 12th ed. Cambridge, Mass.: Winthrop Publishers.
Cherunilam, F. (2008). International economics. 1st ed. New Delhi: Tata McGraw-Hill.
Commodity Basis (2015). Sugar Prices. Available from https://www.commoditybasis.com/sugar_prices [Accessed: 24 December 2016]
Husted, S. and Melvin, M. (2007). International economics. 1st ed. Boston: Pearson/Addison-Wesley.
Mankiw, N. (2014). Principles of microeconomics. 10th ed. Mason, Ohio: Thomson/South-
Mathews, A. (2014). EU sugar beet prices to fall by 22-23% when quotas eliminated. Available from http://capreform.eu/eu-sugar-beet-prices-to-fall-by-22-23-when-quotas-eliminated/ [Accessed: 24 December 2016]
Sexton, R. L. (2015). Exploring Microeconomics. 1st ed. Cengage Learning.
Varian, H. R. (2009). Intermediate Microeconomics: A Modern Approach. 8th ed. New Yprk: W. W. Norton & Company.
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