The Economic Environment of Business




Milk products are generally purchased by all households, however liquid milk accounts for the largest share of this market. On the other hand cheese faces strong competition from other complimentary goods. Health agendas such as the need to consume omega fats, cholesterol lowering products and probiotics in 2005 and 2006 have led to a growth in the market of milk products.

Other market drivers for these milk products are the increased variety of products including flavoured milk, and also the increased advertising efforts by companies. Suppliers and processors of milk products have adopted measures that aid them to act on interest of consumers.


Milk and milk products producing firms assume an oligopoly market structure where there are restrictions or barriers to entry, these barriers to entry are associated with health issues and also the prevention of unhealthy competition, market prices are causing these firms to shut down and also the farmers are under pressure in the production of milk to these prices.

Market structure that exists:

Barriers to entry

Barriers of entry into the milk producing industry is necessary in that it helps in the prevention of unhealthy competition in the industry, if firms were to have free entry and exit then there would be an increase in the level of supply of these products resulting to a very low prices for these products.

Another reason for the barriers to entry is because of health reasons; the government may restrict entry to maintain health standards among the existing firms, in the case where there were many firms it would be difficult to monitor health issues regarding these products and that means health risks to its citizens.


Due to the nature of the market structure there exist price wars between firms, firms will reduce prices in order to increase the quantity sold and in turn increase the level of revenue and profits, firms will therefore seem to be in battle field as they try to increase their revenue and profits at the expense of other firms because the market size of milk and milk products is relatively fixed.

4. The impact on price and output for a firm in the industry if:

(a) Costs rise due to a rise in advertising expenditure

In diagram one the advertising expenses push the marginal cost from MC1 to MC2, this movement is still in the vertical range of the marginal revenue so there are no changes in the price levels of the product. however diagram two illustrate a case where the advertising cost are higher and they cause a shift in the marginal cost curve beyond the vertical range of the marginal revenue, this as result causes an increase in the prices of the product.

(b) The product becomes more fashionable.

The diagram below shows the effect of this:

The marginal revenue curve shifts from Marginal revenue curve 1 to marginal revenue curve 2, the average cost curve shifts from AR1 to AR2, this shows the increase in demand for the product, however in the long run the marginal cost curve will also shift down ward due to increased economies of scale as a result of the increased demand of the product, economies of scale are realised by a firm when it produces optimally, economies of scale are realised when the firms fixed costs are shared across a large number of unit output and therefore the cost of production goes down, however firms may produce to a level where they no longer realise positive economies of scale and a result realise diseconomies of scale.


During this period there was a decrease in the supply of oil and this led to the increase in the level of prices for oil, this decrease in the level of supply of oil is the increased conflicts in the middle east which is largest oil producing region, war in Iraq, Iran’s nuclear program and the instability in Saudi Arabia contributed to this shortage.

Other producing countries such Venezuela were also facing similar problems such as strikes and political problems, all this problems added to the cost of production where there was a rise in the level of insurance premium, Further terrorist groups targeted oil and gas installation to maximise political gains.

This effect of reduced supply of oil can be diagrammatically illustrated below:

Due to the decreased level of supply, the supply curve will shift upwards from supply curve one to supply curve two as shown in the diagram, also bearing in mind that oil has no close substitute the demand for oil is inelastic and therefore the demand for oil does not decrease in this case. The price rises from P1 to P2 and the quantity decreases from Q1 to Q2 gallons.


The hurricane Katrina caused the price of oil to reach an all time high during September; the price of one gallon was 3.04 dollars compared to the previous high price which was 2.38 dollars per gallon.

The diagram that depicts these changes caused by the hurricane to world prices and quantity is shown below:

The rise in the world prices and the decrease in quantity are significantly small compared to the rise in prices and fall in supply of oil between 2003 and 2006. The supply curve in this case shifts upwards from supply curve one to supply curve two, this causes a rise in price from P1 to P2 and also the quantity falls from Q1 to Q2 gallons.


The rise in oil prices since 2003 has caused an increase in the cost of production of milk and milk products, a rise in oil prices is always inflationary and therefore due to the fact that in one way or another oil products are used in the processing and production of milk products then we expect that the cost of production of milk products.

A rise in the level of prices for petroleum products will always lead to an increase in the cost of production for all products in an economy; this is because petroleum products are a key input in the production process either directly or indirectly. A rise in the price of petroleum products will always be inflation ally and will cause a rise in prices in almost all the products in an economy.


Milk producing firms in the UK assume an oligopoly market structure, this structure sometimes is highly competitive while some other times the firms collude and dominate the market. In this type of market the firms always consider the outcome of a decision made to raise or lower prices and the action taken by other firms.

In this type of market if we were to consider a single firm, when an increase in production, increase in taxation or advertising costs go up there is the possibility of two outcomes, the first outcome is where the increase does not shift the marginal cost curve beyond the vertical range then the increase in cost does not result into a change in the price of the product, the second outcome is where the marginal cost curve shifts beyond the vertical range then in this case the price of the product will eventually rise.

In the near future we expect that the companies that produce milk and milk products will exit the industry, this will be caused by the low prices of milk and also the high cost of production to farmers forcing them to stop producing. There is the need for the government to intervene and stabilise this phenomena by subsidising this industry or reducing taxes on milk and milk products.

However in the long run we expect that there will be a reduced supply of milk and milk products which will push the prices of these products up due to high demand, this will lead to more firms entering the industry and the market forces will stabilise both the quantity and prices of these products. Therefore in the short run we expect that there will be a decline in the growth of this industry while we expect a rise in growth in the long run.

When there is a shortage of oil in any major oil producing oil either due to terrorism or natural disaster such as the Katrina hurricane, the price of oil goes up, these results to an increased cost of production, when the cost of production goes up then the customer prices go up, this is to mean that a shortage in oil products is inflation ally. Oil has no close substitute and is a necessity that drives the economies to growth almost all sectors of an economy rely on oil products either directly or indirectly.


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Economic Effects of Hurricane Katrina (2005) retrieved on 15th February

Hugh Stratton (1999) Economics: A New Introduction, Pluto Publishers, USA

Keynote publications (2006) Market Reports- Milk & Dairy Products Market Report, retrieved on 16th February

Mintel International Group (2006) Milk and Cream in the UK, retrieved on 15th February

Paul Anthony Samuelson (1964) Economics, McGraw-Hill publishers, USA

Research and markets (2003) Milk and Dairy Products Market Report retrieved on 15th February

Oil prices between the year 2003 to 2006 (2006) retrieved on 15th February

John Pheby (1988) Methodology and Economics: A Critical Introduction, Macmillan publisher, UK

Ian Livingstone (1970) Economics and Development: an introduction, Oxford University Press, Oxford

Thomas A. and P. Francis (1995) Beyond Rhetoric and Realism in Economics: towards a reformulation of economic methodology, Rout ledge publishers, UK


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