SCP case study: The American agriculture industry

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$Introduction High correlation between the fraction of labor force engaged in$

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
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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Revision

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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

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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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Determinants of concentration

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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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Structure and profitability

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NEIO
Revenue test (Rosse Panzar)
Monopoly: H<0
Perfect competition: H=1
Effect of 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
<
Oligopoly advertising
Keywords: AED/PED, 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.

SCP case study: The American agriculture industry

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