Analysis of agricultural markets 9.1 Introduction Markets exist to facilitate the transfer of ownership of goods from one owner to another. Each time ownership of something changes hands, whether it be a goat or a bicycle, a price is determined. This is true whether the exchange of ownership takes place in a barter economy or using money as the medium of exchange. If in a particular barter transaction ten chickens are exchanged for a goat then the price of the goat is ten chickens and that of one chicken is one-tenth of a goat.
Clearly it is impossible to trade in tenths of a goat, so that if the person originally owning the chickens had had only five he would have been unable to conclude a barter exchange with the goat owner unless the latter could have been persuaded to accept the much lower price of five chickens per goat. Putting together barter deals is a cumbersome way of achieving transfers of ownership. It is far easier to arrange this in a money economy, where chickens and goats can both be sold for units of currency. In this way the goat owner may be able to buy the chickens without having to sell his goat to the chickens' owner.
He can sell his goat at a money price equal to that of ten chickens, and then spend half of the notes or coins he receives on buying the five chickens on offer. In the previous chapter exploring the nature of market equilibrium, the equilibrium price was presented as that which enabled the last marginal unit supplied to the market to be sold to a willing consumer for money. At a higher price less would be demanded even though producers would find it profitable to sell more, while at a lower price consumers would like to purchase more but producers would only find it profitable to supply less. The equilibrium solutions examined in Chapter 8 were all derived for markets which were assumed to be subject to perfect or pure competition 168 Analysis of agricultural markets (many buyers and sellers).
In practice, however, not all markets are competitive. Some may be oligopolistic (few sellers) and in others competition may be typified as approximating monopoly (one seller) or monopsony (one buyer). Oligopoly is not common in agricultural product markets although it may occur in markets for modern industrially produced inputs. It will not therefore be discussed in this chapter.
Monopoly and monopsony are however important features of agricultural product markets due to the creation of state trading organisations, often called marketing boards. The first half of the chapter is therefore devoted to a comparison of market equilibrium in conditions of monopoly and monopsony with that which would occur where there are many buyers and sellers. Exchanges of ownership do take place directly between producers (farmers) and food consumers. This is particularly the case in less- developed countries where it is not uncommon for members of producers' families to transport surplus produce to a nearby market for direct sale to the final consumer; but in industrialised countries the proportion of output sold in this way is very small and the bulk of produce is sold off the farm to wholesale merchants, special state commodity trading organisations, or directly to large food processing firms.
In these markets much farm produce is transformed (e. from wheat to cakes and biscuits), often using industrial food processing techniques, before being sold through supermarkets or restaurants to final consumers. In these circumstances the immediate demand for farm produce arises not from households but from a variety of firms and state organisations and it is shops, restaurants and supermarkets which supply food to households not farmers. These structural characteristics of food and agricultural markets are of considerable importance and Sections 9.5 of this chapter are devoted to a brief consideration of the interaction of supply, demand and price formation at identifiable stages (i.
ownership exchange levels) in the distribution chain running from the farm to food consumption by individuals and households.2 Degrees of market competition 9.1 Many buyers and sellers In examining how markets achieve or move towards equilibrium it was argued, in the last chapter, that it is produced by the competitive interaction of many buyers and sellers each acting to maximise their satisfaction (utility) and profits respectively. For economists a special form of this, which is sometimes called perfect competition, is commonly Degrees of market competition 169 used as a paradigm or standard of market behaviour. This is because, as we shall see in the next chapter, perfect competition (or the slightly weaker form pure competition) is assumed to result in price-quantity equilibria which are economically efficient in a special sense. A perfectly competitive market for a good or commodity is one defined to have the following set of properties: 1.
Firms are independent profit maximisers, and consumers are utility maximisers with independent tastes. There are many sellers (firms) and buyers (consumers), none of whom has a large enough market share for their decisions to affect market prices. Sellers and buyers are price takers. All firms have identical technology, production functions and management ability.
The product is homogeneous so that consumers are indifferent between the produce of alternative suppliers. Factors of production are freely mobile in the economy, so that there are no barriers to firms wishing to enter or leave the market. Seller and buyers have perfect knowledge and foresight about market conditions, and adjust their decisions accordingly. For many analytical purposes these are an unnecessarily restrictive set of conditions and it is sufficient for markets to be efficient that pure competition should exist in which properties 3 and 6 above are relaxed.
Very often, to avoid the overtones of superiority associated with the words 'perfect' and 'pure', economists use the term atomistic competition to describe markets in which many buyers and sellers compete in pursuit of their own personal advantage. Because price and quantity (equilibrium) determination in competitive markets has already been examined in Section 8.2 of the previous chapter it will not be repeated here. It is however worth recalling that a competitive equilibrium exists where the market demand curve for the product concerned intersects with its market supply curve. (The former is the sum of the demand curves of all consumers for the product, and the latter the sum of the upward sloping portions of the marginal cost curves of all the competitive firms producing the product.) In such an equilibrium competitive firms equate the market price (their marginal revenue) with their marginal cost of production.
170 Analysis of agricultural markets 9.2 Monopoly The market structure which is the polar opposite of perfect competition is termed monopoly. Its distinctive feature is that there is a single supplier of the product but, in addition, it requires (i) that there should be barriers to entry of new suppliers and (ii) that there are no close substitutes for the product. If these two conditions were not met, monopoly would be a short-lived phenomenon. The monopolist, as the only seller of the product, faces the market demand schedule, which in general is expected to be downward sloping.
The reader will recall that, in contrast, the competitive firm has a horizontal demand curve for its product, since it can sell any quantity at the (given) market price. Moreover, the total revenue curve for the monopolist is not a straight line as in Fig. The monopolist's total revenue function can have a variety of shapes, Fig. The monopolist's demand (/)), marginal revenue (MR) and total revenue (TR).
Price (a) Quantity MR Total Revenue Quantity Degrees of market competition 171 depending on the precise nature of the demand curve. If, for simplicity, we assume that the downward-sloping demand schedule is linear, the total revenue curve takes the form shown in Fig. In the elastic portion of the demand curve, total expenditure by consumers (and hence total revenue for the producer) increases as price falls; in the inelastic section total revenue decreases as price falls. At the midpoint of the linear demand curve, demand is unitary elastic (that is the price elasticity of demand = 1) and, as we shall see, total revenue is at a maximum.
It is usual to assume that the monopolist's marginal cost function is equivalent to the supply curve of the competitive industry. That is, for purposes of comparing competitive equilibrium to that under monopoly, the monopolist is treated as if it had taken over all the competitive firms in the industry and was operating with their collective cost structure. The monopolist is also assumed to seek to maximise profits. The output level which maximises profits, is found at Qo in Fig.2 where the difference between total revenue (TR) and total cost (TC) is greatest.
At this level of output, the slopes of the curves are equal, implying that marginal cost (MC) equals marginal revenue (MR). This will be recognised as the same condition for profit maximisation as was established in the analysis of the competitive firm. However, for the competitive firm, price (or average revenue, AR) and marginal revenue are identical; for the monopolist, the MR curve lies below the AR curve and price (P) is greater than MR. An additional feature of the solution is that as long as total costs rise with output, the profit maximisation point will be located on the rising portion of the total revenue curve, that is, where demand for the product is elastic.
We shall elaborate these points below. The monopolist's profit maximising output. Total Cost Total Revenue Quantity 172 Analysis of agricultural markets The relationship between marginal revenue and price is given as: 1 (9.1) where e denotes the price elasticity of demand. Since e has a negative sign, equation 9.1 implies that P > MR, except in the special case of perfectly elastic demand, 2 and the more inelastic the demand curve, the greater the difference between price and marginal revenue.
Furthermore, note that marginal revenue is positive where demand is elastic (|e| > 1), negative where demand is inelastic (|e| < 1), and zero where demand is unitary elastic (| e | = 1). These relationships are illustrated, with the aid of a linear demand curve in Fig. By superimposing (in Fig.3) 'typical' U-shaped cost curves on to the demand (average revenue) and marginal revenue curves, an alternative illustration of the (short run) monopolist's profit maximisation solution can be derived and this can be compared to equilibrium in a competitive market. At Qo, marginal costs and marginal revenue are equal.
The price charged is PQ, the price associated with Qo on the demand curve (that is Qo is determined by the intersection of the marginal revenue and marginal cost curves of the monopolist). Po equals average revenue (AR(Q0)) and since this clearly exceeds the average cost of producing Qo, AC(Q0), the monopolist earns supernormal profits shown by the shaded area as equal to AR(Q0)-AC(Q0) times the number of units produced, Qo. Equilibrium for the monopolist. Price Qo Q2 Qx Quantity Degrees of market competition 173 equilibrium can be directly compared to that of a competitive industry which would occur where marginal cost and average revenue are equal \ at price Px and quantity Qv It can therefore be seen in the context of this comparison that monopolisation of a competitive industry would result in lower output, higher prices to consumers, and supernormal profits to the monopolist.
While it is not reasonable to assume that any firm would suddenly wish to take over a myriad of small firms and turn a competitive industry into a monopoly, this comparison provides a simple explanation of why society usually arms itself with powers to control monopoly and to prevent firms exploiting monopoly power to drive up prices and obtain excessive profits. It should also be stressed that the monopolist does not have control over both price and output.