Microeconomics Essay Example | Topics and Well Written Essays - 1250 words

Microeconomics - Essay Example There is a huge demand for Australian iron ore in China due to the high quality of the ore. The high Chinese demand for iron ore has also led to the hike in prices of iron ore in the world market (Rutkowski, 2010). All these have benefited the export of iron ore from Australia especially the Western provinces. According to reports China serves the biggest market for Australian export and the value of export of iron ore from west Australia was $13.82 billion in 2007. This was almost 60% of the net export of Australia (Zpryme: Emerging Markets Group, 2008). The wage rate has also increased steadily in Australia with mining being the highest paying occupation. A study of the regional developments in Australia shows that West Australia is the second state with the highest average annual wage at $70,101. The surge of export is expected to continue in the future. As a result it paints a bright picture for the forecasts about GDP growth. Australia has an unemployment rate of 5.2% which is v ery close to full employment and in the mining regions of Western Australia it is 4.7% (Australian Regional Labor Market, March Quarter 2011). Impact of increasing demand for iron-ore The high demand for steel by China has led to a rise in the global price. The global iron market uses an annual benchmark system for pricing. By this system the iron mills enter into a contract with the producers of iron ore for a period of one year and that price is followed for all transactions till the next year when the prices are revised. Iron is a very important component in all the manufacturing goods. So the iron mills want to ensure that there is no random fluctuation in prices that destabilizes the market. However in the rise in iron ore prices at a fast rate from $37 per ton in 2004 to $101 per ton in 2009 has led the major iron ore manufacturing countries like Australia, Brazil, and China to lobby for a shorter period of contract. This will allow the companies to revise the prices sooner an d thus make higher profit. The Chinese demand for iron ore is exogenous and depends on the global demand of steel. In other words the demand for iron ore in China does not depend on the price of the iron ore but on the global demand for steel. This is evident from the fact that in the previous years we have seen a simultaneous rise in the price of iron ore as well as demand for the ore in China. Therefore, though a short term contract will lead to an increase in the cost of production it will not necessarily reduce the demand for the Chinese steel (Rutkowski, 2011). For this reason, though Chinese steel mills are trying to negotiate the short term contracts, but their high demand for steel to continue operations has made them unable to have advantageous ground in these negotiations. We shall explain the logic with the help of a diagram. d d’ s’ P’ P s d’ s’ d O q q’’ q’ In the above diagram, we have tried to show the effect on the price of iron ore for a shift from short term to long term contracts. A long term contract fixed the price at a level p for any quantity. As a result the supply curve PS becomes inelastic. An exogenous rise in demand for goods shifted the demand curve from dd to d’d’. Since the price remains fixed, the equilibrium quantity rises from Oq to Oq’. However a short term contract would make the supply curve more elastic. Regular revision of