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Lecture 10

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SCP case study: The American agriculture industry

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$Introduction High correlation between the fraction of labor force engaged in agriculture and GDP per capita. In poor nations, 50-80% work in...$

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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

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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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Structure

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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

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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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Revision

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Module structure

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The SCP paradigm Structure  Conduct  Performance

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SCP: Endogenous relationship? 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

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Concentration and profits in America

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Market power and welfare

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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

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Determinants of concentration

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Determinants of concentration

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Views on SCP

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Structure and profitability

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NEIO

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Conduct

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Market structure and advertising

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Market structure and advertising

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Welfare and advertising

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R&D and market structure

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R&D and market structure

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Innovation protection

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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