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SCP case study:
The American agriculture industry
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Introduction
High correlation between the fraction of labor force
engaged in agriculture and GDP per capita.
In poor nations,
50-80% work in agriculture
In rich countries, 2-4% work in agriculture
Unique organization: Farms are mostly family-owned, rather than publicly listed firms.
Farms typically operate as price takers.
Productivity growth in US agriculture has exceeded that in the rest of the economy
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Structure – Supply and demand
Farmers must make substantial
investments before production starts [sunk costs]
Investments cannot be adjusted
in the short run → inelastic short-run supply
Supply can shift unexpectedly due to weather and disease conditions
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Structure – Supply and demand
Demand for most farm
commodities is price-inelastic: food is a necessity
Unexpected supply or
demand shocks lead to sharp price fluctuations
Farmers face price risks in addition to yield risks
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Structure
Short-run supply is inelastic, but easy entry makes
long-term supply curves elastic
Rapid productivity growth → supply curves
have shifted to the right
Demand growth has been limited by low population growth
As a consequence:
Real prices for agricultural commodities have been decreasing
Export markets have become increasingly important
With the rise of exports, farmers face additional risk: exchange-rate risk, foreign macroeconomic risks, etc.
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Trends in US farm structure
The number of farms
peaked at 6.8 million in 1935, and declined to
2.3 million in 1974 and 2.1 million in 2002
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Trends in US farm structure
Sharp restructuring of agriculture
towards larger operations
The median farm size has increased
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Family farms, profits and household income, 2003
Large farms
are more profitable than small farms
? Driving increase
in farm size
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Variation in profitability
Considerable variation in profitability, many small
farms remain profitable:
Risk variability (climate, natural disasters, price shocks)
Skill
disparities
Product innovation by small farms → niche markets through marketing, special products (kiwi fruit, tofu-variety soybeans etc.) and/or special product attributes (free-range chicken, organic vegetables etc.)
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Structure: commodity markets
Farmers are price takers in almost
all commodity markets
The same is not true of buyers:
processors, packers and retailers → monopsony power tendencies
Sources of monopsony power:
High nationwide concentration (e.g. packers of fed cattle CR4 = 80%)
High transport costs (e.g. fed cattle are shipped less than 160 km → regional monopsony even if there are several national buyers)
Perishability (e.g. livestock lose value when they are stored beyond their optimal weight → time-constrained search for better deals)
Specialization (e.g. a buyer’s demand causes a farm to plant a highly specific variety tailored to the buyer’s request → asset specificity)
Asymmetric information (buyers make hundreds of deals per day; sellers make a few deals per year)
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Vertical linkages
A large share of farmers rely on
long-term contracts with a specific buyer, ranging from 10%
for wheat to 91% for poultry and eggs
Long-term contracts are more common when farmers face perishability and transport cost problems (→ fewer potential buyers)
Prices may be set by the contract, and shift the risk price fluctuations
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Conduct: Farmer cooperatives
Farmers are price takers, but
they buy from and sell to firms with growing
market power.
Inputs: machinery, seed, petroleum, pesticide…
Industries processing farm commodities are increasingly concentrated.
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Conduct: Farmer cooperatives
Farmers seek pricing power by
organizing cooperatives → attainment of market power is difficult
as entry costs are low.
Cooperatives have little market power over consumers, but are sometimes effective in countering the monopoly power suppliers and the monopsony of buyers.
Because farmers are price takers, they are allowed to sell through cooperatives, violating the Sherman Act.
Most cooperatives do not differentiate their products.
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Performance
High rates of agricultural productivity growth over a
long period.
100 years ago, an American cow yielded 3,840
pounds of milk, while in 2006 it yielded 20,000 pounds!
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Performance
Total factor productivity accounts for the quantity of
all inputs that is used to produce a specific
output
TFP growth per year in agriculture 1950-2004: 2.10%
TFP growth per year in private non-farm businesses 1950-2004: 1.15%
Because of high TPF growth in agriculture:
Nominal farm product price increase 1980-2005: 15%
Overall price increase 1980-2005: 122%
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Sources of technological change/innovations in agriculture
Equipment: mechanical power
replaced human/animal power; machines became faster and more reliable;
IT allows better monitoring of production…
Chemicals: Chemical fertilizers replaced pesticides, herbicides and fungicides improved the control of weeds and diseases …
Genetics: Plant breeding research created higher-yielding plants with better survival traits; livestock and poultry genetics have caused increased meat yields per animal …
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Sources of technological change/innovations in agriculture
Farmers rarely develop
the innovations themselves. Most are developed by researchers in
the nonprofit sector.
Early adopters of a technology derive only temporary benefits. Cost reductions increase supply, driving down prices.
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Overall performance over time
More efficient production over time.
Larger
farms have tended to be more efficient → gradual
increase in concentration, but farming is still relatively decentralized in the US
The real prices of most food products have decreased over time, which is partly due to process innovation in farming
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Module structure
Structure
? Conduct ? Performance
Market definition
Concentration measures
Concentration determinants
Testing
SCP, NEIO
Advertising
R&D
Market power & welfare
Product Differentiation
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Structure ? Conduct ? Performance
The
SCP paradigm
The number and size distribution of firms
Entry conditions
Vertical
integration and diversification
Pricing strategies
Advertising
R&D
Differentiation
Collusion
Mergers
Profitability
Growth
Quality of products
Technical progress
Productive efficiency
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Structure ? Conduct ? Performance
Conduct
to structure? R&D, advertising, differentiation
Performance to structure? Growth and
changing market shares
Performance to conduct? Profitability and capacity to invest in R&D, or cut prices
SCP: Endogenous relationship?
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Concentration and profits in America
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Market power and welfare
Application to internet monopolies
Does the
internet favour such quasi-monopolies?
Are digital monopolies less harmful than
traditional monopolies?
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Market definition
Relevant product market
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Market definition
Relevant geographic market
CED and CES analysis
Limitations of
market definition
Market definition remains arbitrary
Critical values of CED, CES?
Importance
of market definition
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Measures of concentration
Hannah –Kay criteria
CRn
HH
HK
Gini
Advantages?
General Limitations?
Specific Limitations?
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Determinants of concentration
More concentration
Less
concentration
Sunk costs: endogenous or
exogenous
Industry life cycle
Gibrat’s law
Entry barriers:
Economies of scale
Absolute cost advantages
Product
differentiation
Switching costs
Network effects
Regulations
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Views on SCP
Abuse of market
power
Concentration
Profits
Efficiency
Profitability
Firm
Growth
Concentration
SCP:
Chicago:
school
Issue 1:
Measurement of profitability
Tobin’s Q, ARP, price-cost margin
Issue 2: Testing
the two paradigms
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NEIO
Revenue test (Rosse Panzar)
Monopoly: H
costs on revenue
Structural approach
Effect of q(i) on industry output
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Conduct
Implications of market structure
Advertising
R&D
Product differentiation
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Market structure and advertising
Dorfman-Steiner condition
Monopoly advertising
impact of advertising on market shares
Empirical evidence: inverted U-shaped
relationship between advertising and concentration
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Market structure and advertising
Concentration
Advertising
Dorfman-Steiner
Entry barriers, sunk costs,
Informative vs.
persuasive advertising
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Welfare and advertising
Persuasive advertising
Which preferences to consider?
Advertising can
increase/decrease welfare
New or original tastes
Most cases: higher quantity,
lower consumer surplus, higher producer surplus
Informative advertising
Reduced search costs
Welfare effects through market structure
Informative vs. persuasive advertising
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R&D and market structure
Schumpeter hypothesis
Prospect of monopoly power
Arrow
Replacement
effect
High concentration
Perfect competition
Potential entrant model
Efficiency effect
Monopoly
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R&D and market structure
Development time
Incentive to accelerate innovation
Oligopoly?
Dasgupta
& Stiglitz
Aggregate R&D
Monopoly
Importance of the industry context
Empirical evidence: Aghion
et al 2005
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Innovation protection
Patents
Optimal patent system
Trade-off:
R&D expenditures and DWL
Length vs.
breadth
Side effects of patent policy
Hurt innovation?
Excessive R&D
Do patents matter?
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Product differentiation
Sources of differentiation
Geography
Technology
Brand
Preferences
Services
Factors influencing differentiation
Monopolistic competition
Elasticity of
substitution
Economies of scale
Hotelling’s model
Price flexibility
Strategic behavior
Entry threats
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Exam structure
1.5 hour
Secton A: Answer ONE question from
TWO. ? Two essay questions
Section B: Answer ONE question
from THREE. ? Two essay questions + one conceptual question
All questions carry equal marks.
Broad questions
Theoretical explanations
Empirical evidence to support your claims
Poor answers
No intuition provided for the theory
No empirical evidence or example
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Do not reproduce prepared essays without regard to
what the question asks
Before you answer…
Choose to answer only
those questions you fully understand
Your Answer…
The Main Body of argument should follow, with evidence, examples etc used to support statements
Should have a clear structure
The Introduction should act as a signpost to the reader
A (brief) conclusion should end the essay
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Good Practice
Use examples whenever possible to support arguments
Define
technical terms as you introduce them, especially any such
terms that are specified in the question
Credit is usually given for examples and evidence that goes beyond lecture notes
Use equations, graphs, figures etc where relevant
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More Good Practice
Label graph axes etc.
Explain diagrammes or
figures
Equations/figures etc that are merely reproduced without comment do
not improve answers
There is no need to do a list of references
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Bullet Points Answers?
Reproducing bullet points does not constitute
a good answer, even if the points are relevant
Try
to write a coherent explanation
If you really run out of time on the last question, brief notes indicating how the answer should have developed may help.
