Is There Still a Need For Olive Oil?

 Troubled Times for the Olive Oil Industry

      
         According to an article of Olive-oil prices posted on 22^nd September2012 on http://www.economist.com/node/21563304  from the print edition, when it comes to the production of olive oil, Spain tops the list. Spain which is located in the Mediterranean has the highest production of olive oil. This is due to the ideal climate for growing olive groves and the factors of production such as sufficient land, capital and efficient labourers.

      But a current drought in Spain will have a huge impact on the production of olive oil. This will cause the supply of olive oil to decrease which will cause the supply curve to shift to the left, which will result in an increase in price of olive oil as shown in Figure 1. The producers of olive oil in Spain have been mass producing olive oil, this has induced a continuous shifting of the supply curve to the right which causes the price of olive oil to keep falling as shown in Figure 2. The price has fallen to its all-time low seen for the past 9 years.

Figure 1

Figure 2

      For these 9 years, the consumer surplus has been increasing because they have been able to purchase the olive oil and lower prices. However the price “extra virgin olive oil” which is the top range of olive oil has increased by over 50% due to the surplus in stock from the previous year. The supply of “extra virgin olive oil” is therefore able to meet the demand of consumers. The demand for “extra virgin olive oil” has been increasing causing the demand curve to shift to the right and since there is a surplus in stock from the previous year, the supply curve is already able to cope with the demand. Thus creating a new market equilibrium with a higher price and with more “extra virgin olive oil” being purchased.

      When the price of “extra virgin olive oil” increases the demand for a substitute such as vegetable oil will increase. The demand for complements of “extra virgin olive oil” such as salads will fall. But it all depends on whether the demand for “extra virgin olive oil” is inelastic or elastic. If it is inelastic an increase in price will not affect the quantity of bottles of “extra virgin olive oil” being demanded. Where else if the demand is elastic an increase in price will heavily affect the number of “extra virgin olive oil” bottles being bought. Therefore the producers of the “extra virgin olive oil” have to be smart on how much they produce in order to maximise their total revenue. If they are looking at consumers who have elastic demand they should sell at lower prices but if the consumers have an inelastic demand then they should sell at higher prices.

      Producers have to anticipate the movement of their competitors if they wish to maximise their profit. They have to plan well in terms of the short-run and long-run production, this is because olive oil is harvested from the olive grove plants and olive grove plants take time to grow. This is why if a producer notices a sudden surge in demand for olive oil then they will not be able to produce enough olive oil to meet the demand and will lose out in terms of sales to their competitors. The producers will also have to monitor and have a forecast of how the market is going to turn out.

      If the demand for “extra virgin olive oil” continues to increase, this will lead to new firms coming in to try and make some profits for themselves since the market is doing so well. This will cause some competition, but it depends whether the market is actually control by a monopoly company. If it was a monopoly company, it could eliminate all the newly formed firms by selling the olive oil below the market price thus killing all competition. But since the demand for olive oil is of high demand right now many firms will enter the market and try to compete with the existing firms. If more and more new firms established, the monopoly cannot forever be selling at low prices, as it will cost the monopoly firm a big lost and eventually shutdown as well.

      The producers have to be both allocative and productive efficient in order to be truly efficient. Allocative efficiency is a point where the marginal benefit is equal to the marginal cost. In other words the producers must be producing a good which is socially desirable or high in demand. Productive efficiency is where the producers have to be producing at the lowest average total cost.  This is so that the producers can save money by producing at the most cost minimizing level without affecting the quality of the product. These 2 types of efficiency are crucial for a firm to succeed in the olive oil business.

      However the European Union is concern of the quality of olive oil which is being mass produced in Spain and therefore has decided to cut subsidies given to the producers. By cutting the subsidies the cost of producing olive oil has increase. Producers now cannot produce as much as they could previously, this will shift the supply curve to the left which will raise prices. By doing so, the European Union may just have killed two birds with one stone by increasing the price of olive oil which has been at its lowest price for the past 9 years and also reassuring that the quality of olive oil as it cannot be mass produce anymore. The subsidy should be removed only from the larger firms which are mass producing the olive oil and not for the whole sector of firm which are producing olive oil. The newly established firms rely heavily on the subsidies to produce the olive oil, removing the subsidy from them may very well force them to meet their end. Subsidies can help raise production, thus moving the supply curve to the right as shown in Figure 3.

      All in all, the supply and demand of olive oil will determine its selling price. Since there has been a drought in Spain which has severely affected the growth of the olive groves which will decrease the supply of olive oil in the near future, prices are expected to soar sky high. Both of the consumers and producers of olive oil will face difficult times ahead.