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Economics and the 2008 crisis: a Keynesian view
Economics and the 2008 crisis: a Keynesian view

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Cost of producing a pint

Producing a pint of milk is a costly business. Firms producing milk, usually referred to as dairy farms, take inputs in the form of land, capital (the herd, milking parlours and storage) and raw materials (such as feed and seed). They then use these inputs to make milk, which can also be used to produce cheese and yogurt.

Activity 26

Some farms may receive income from the government, but like all firms, if their income doesn’t cover the cost of milk production, they risk going out of business. Watch this short video on the challenges facing milk producers, which introduces one of the main ideas covered in Section 7: reducing cost. Notice how the video uses ideas from short run and long run cost curves.

Whilst watching the video, think about the key challenges milk producers face and what they can do to reduce these challenges. Make some notes on your thoughts here – you will need to refer back to them later on.

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Costs of milk production
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Discussion

Here are some notes about the video – you may have some similar points in your notes.

  • Costs of production are high, sometimes higher than the price dairy farmers are paid, and rising.
  • Milk prices are falling.
  • Farmers have difficulty investing in new equipment to replace worn or old equipment – this wear and tear cost is what the presenter, John Craven, refers to as ‘depreciation cost’.
  • Some producers are considering stopping milk production.

Possible responses to reduce cost:

  • Invest in new technology to shift the farm’s long run cost curve downwards, for example, by buying more equipment that is more efficient to run, or updating their production process (production function) to reduce labour input. However, this is difficult if the farmer cannot afford to increase their fixed cost in the short run to purchase new equipment.
  • Gain from economies of scale by increasing their scale of output, like in the mega dairy example. If firms invest in new technology, not only may they experience a downward shift in the LRAC, they may also benefit from decreasing unit cost as output increases. This may be as a result of economies of scale arising from indivisibility – that costs per unit of output from running and maintaining new technology or machinery will decrease as output increases. Other indivisibilities may arise from the running of the farm office and administration, which have a fixed cost whether the farm has a high or low output, but if spread over higher output, will help to decrease average cost.
  • Stop producing milk.

Challenges:

  • Most farms are small in the UK, and land is scarce and expensive. It may not be easy to increase the scale of the business, like in the mega dairy example.
  • Some overseas producers already produce at a lower cost per pint.
  • Economies of scale require investment in production, which is difficult when making a loss.
  • Issues of animal welfare related to the mega dairy.