ECON8069 Business Economics |Article Analysis with Economic Theories

Introduction

Manufacturing in Australia holds an important position in the economy. Food and beverages, textile, chemical, machinery and equipment, wood and paper products, metals and non-metal minerals are some of vital sectors of Australian manufacturing. Large scale manufacturing always has high demand for energy (Toner and Stilwell, 2014). Being highly energy intensive, growth of manufacturing is aligned with the energy sector. After years of good performance, the sector has now experienced a relatively slow growth rate mainly due to a rising cost of electricity. The paper focuses on recent trend of declining growth in manufacturing following an increasing input cost.

Article Summary

The manufacturing sector of Australia has marked a slow-down in its steady growth rate in the face of an increasing energy cost. In addition to rising energy cost, other two factors contributing to a decline in manufacturing growth are a relatively high value of Australian dollar coupled with closure of some firms in automobile sector. The performance of manufacturing sector is indicated by Purchasing Managers Index (PMI). The Index has now reached to 51.1 percent recording a decline by 3.1 points. With this, the PMI index has reached to its lowest level. In just two months ago, the index stood at 59.8 percent (businessinsider.com.au, 2018).  In the measure, 50 is taken as a benchmark value. Any value above or below 50 indicate contraction or expansion of the sector. The PMI index though is above 50 but it marks a much slower growth than that in 2016.

In the manufacturing sector, the local demand mostly generated from construction sector, defense, agricultural equipment, mining equipment, renewable and other utilities. The manufacturing sector has faced a high input cost. The increase in input cost resulted from increasing cost of gas and electricity. With an increased cost of production the profit margin of manufacturers has declined significantly (macrobusiness.com.au, 2018). The lower profit margin more than offset the local demand. Among the eight major subsector six were recorded an expansion in October. The good performance of non-metallic subsectors of minerals and food and beverages sectors helps to offset poor performance in other sectors. The combined performances of different sub sectors of manufacturing has kept the performance index above the marked level of 50.

The manufacturers though experience an increase in orders and sales but it is much slower as compared to that in the previous year (businessinsider.com.au, 2018). The rising cost of input leads to a contraction of output. Increasing value of Australian dollar hurts manufacturing export and further contribute to a decline in manufacturing growth.

Article analysis with economic theories

Cost of production is an important component in determining operation of firm. The optimal production point is determined from the average and marginal cost of firms. Costs faced by firms at every unit of production is called average cost (Arrow, 2015). Marginal cost on the other hand measures the additional cost associated with additional output. The margin of profit is determined as total revenue less total cost. The profit maximizing always aims to minimize its cost. By charging a price well-above the average cost firms can earn sufficient profit even in the long run. If input cost rises, then average cost of production rises as well causing a decline in profit margin (Moulin, 2014).

The manufacturers in Australia are now facing high input cost. The construction sector for example faces a high price for electricity and gas. This is mainly due to Australia’s attempt to make a drastic shift to the renewable sources (abc.net.au, 2018). Many coal and gas power station has closed down in Australia to meet the emission target. The sudden supply shortage leads to a rising cost of energy. Another source of rising input cost arises from the rising cost of wags from a shortage of skilled labors (Hasan & Boateng, 2017).The construction sector is suffering from a lack of workers who can match their requirement.

Figure 1: Rising input cost and effect on profitability

(Source: as created by Author)

In order to understand the effect of rising cost on profitability, a comparison has made under two different cost situation. AC₁ and MC₁ are the initial low level of average and marginal cost. At this cost, profit is shown as thee rectangular area of P₁ABC. An increase in input cost shifts the cost curves upward. With a higher cost profit is now declined to P₂abP₁ (Stoneman, Bartoloni & Baussola, 2018).

Recommendation

Energy is the most important input in the Australia manufacturing. Initiatives should be made to supply electricity or gas at an affordable price. The energy plants should be subsidized to offer electricity at a relatively cheaper price. The existing coal or gas station should not be close down as long as sufficient renewable energies are not produced to substitute the traditional ones. The skill shortage is a major driver of rising cost of wage. The workers should be trained to match skill requirement. The aspect of rising cost should be addressed to regain the growth pace of manufacturing.

Conclusion

The manufacturing sector in recent years has accounted a slow-down. The PMI measure used to indicate performance of manufacturing has reached to 51.1 point from 59.8 points. Construction, agricultural and mining equipment and defense are some major source of local manufacturing demand. The construction sector has slowed down because of a rising energy and wage cost. Some non-metallic subsector along with growth food and beverage sector has performed better compared to other sectors. In addition to rising input cost, appreciated value of Australian dollar contributes to a decline in manufacturing export. 

References

Arrow, K. (2015). Microeconomics and operations research: Their interactions and differences. Information Systems Frontiers, 17(1), 3-9.

BlueScope doubles profit but warns of rising energy costs, cartel investigation. (2018). Retrieved from https://www.abc.net.au/news/2017-08-21/bluescope-doubles-profit-but-warns-of-rising-energy-costs/8827752

Economist, U. (2018). Australia's huge manufacturing labour costs - MacroBusiness. Retrieved from https://www.macrobusiness.com.au/2014/01/australias-huge-manufacturing-labour-costs/

Hasan, M., & Boateng, A. (2017). A Review of Manufacturing in Australia. Journal of Public Administration and Governance, 7(3), 47-64.

Moulin, H. (2014). Cooperative microeconomics: a game-theoretic introduction. Princeton University Press.

Scutt, D. (2018). Australia's manufacturing sector is slowing down as surging energy costs start to bite. Retrieved from https://www.businessinsider.com.au/australias-manufacturing-sector-is-slowing-down-as-surging-energy-costs-start-to-bite-2017-11

Stoneman, P., Bartoloni, E., & Baussola, M. (2018). The Microeconomics of Product Innovation. Oxford University Press.

Toner, P. and Stilwell, F., 2014. Why does Australia need manufacturing industry?. Australian Options, (75), p.21.