In order to answer these questions, you will need to read Chapter 9: " Market Equilibrium & Product Price - Imperfect Competition

Question #1:

Explain the 3 types of "Imperfect" market structures used in selling goods. For each type of market structure, give an agriculturalexample.

Question #2

Explain the concept of "entry barriers". What are some examples of entry barriers seen in agricultural business? Which type of market structure most often uses entry barriers to limit competition?

Question #3

Explain the difference between "Monopolistic Competition" and "Perfect Competition". Why would an agricultural producer choose to become a monopolistic competitor?

Question #4

What is an agricultural cooperative? What are the benefits of belonging to an Agricultural Cooperative for a farmer? Explain the Capper-Volstead Act and how it impacts farmers involved in cooperatives.

Question #5

How does the Federal Trade Commission discourage the formation of monopolies? What are 3 key regulatory measures that the FTC can utilize to discourage monopolists in addition to legislative acts?

conomics_by_John_B._2925079_(z-lib.org).pdf 173 / 433 87% + 172 CHAPTER NINE MARKET EQUILIBRIUM AND PRODUCT PRICE: IMPERFECT COMPETITION Economic Environment Of the many aspects affecting the economic environment in which an industry oper- ates, the one most closely related to the behavior and determination of prices is exist- ing supply and demand conditions. Three aspects of supply and demand particularly important to determining price in a market are 1. the level of output in the industry, 2. the responsiveness of supply and demand to price changes and the respon siveness of demand to income changes, and 3. the proportion of consumer food expenditures accounted for by the indus- try's product. If an industry's sales volume is relatively large, more profit opportunities will be available for firms to be involved at all levels. This situation makes it difficult for one or a few buyers or sellers to control prices. The opposite is the case if volume is low. If demand is highly responsive to changes in price and income-which is referred to as an elastic demand and consumers spend a large portion of their incomes on the product, the industry will grow when income rises and prices fall. Opportunities for new entrants in this industry will be present, increasing the com- petitiveness at each level. If demand is instead largely unresponsive to price, referred to as an inelastic demand, if demand also is unresponsive to income change, and con- sumers, on average, spend only a small proportion of their income on the product, demand will be stable and growth will stagnate. To summarize, we can classify forms of market structure, in part, by the number and size distribution of sellers and buyers. the degree of market concentration by the firms. the degree of product differentiation, the barriers to entry, and the economic environment in which firms operate. Classification of Firms Four major conditions, combined, define perfect competition and guarantee a mar- ket in which the forces of supply and demand determine prices. These conditions are: (1) a large number of buyers and sellers; (2) a homogeneous product; (3) freely mobile resources; and (4) perfect knowledge of market conditions. The conditions for perfect competition are extreme, but examples of nearly Imperfectly Competitive perfect competition abound in agriculture. In selling activities, numerous small pro- Market Structures ducers of livestock and crops are producing a nearly identical product. In buying Imperfectly competitive forms of market structure activities, numerous consumers are purchasing food and fiber products that are not can be classified according highly distinguishable. The important result of the conditions of perfect competi- to the number of firms and tion, or even near-perfect competition in a market, is that buyers and sellers are price size distribution in the mar- takers, not price makers. The actions of any individual buyer or seller do not affect ket, the degree of product the market. The interaction of market supply and market demand determines the differentiation, the extent of barriers to entry and und market price in a perfectly competitive market environment. the economic environment Market structure from the seller's perspective can be classified into four types, within which the industry based on the extent to which market prices are set by the forces of supply and operates. The profit-max- demand. These four types of competition in selling are imizing level of output for any imperfectly competitive 1. perfect competition, firm is determined where 2. monopolistic competition (imperfect competition), marginal revenue equals 3. oligopoly (imperfect competition), and marginal cost. . monopoly (imperfect competition).\fCHAPTER NINE MARKET EQUILIBRIUM AND PRODUCT PRICE: IMPERFECT COMPETITION Table 9-1 RELATIONSHIP BETWEEN DEMAND (AVERAGE REVENUE), TOTAL REVENUE, AND MARGINAL REVENUE Average Revenue or Demand Curve Total Revenue Marginal Revenue Price (Change in Total Quantity Elasticity of (Price x Quantity) Revenue) Demand 28 -29 -0.20 Demand = Average revenue Total revenue Total revenue price 0: 88 88838 8861 Marginal revenue 10 15 20 25 30 15 20 25 30 Quantity Quantity Figure 9-1 The relationships among average, marginal, and total revenue in these figures are based on the data in Table 9-1. These concepts determine equilibrium prices and quantities in the case of imperfect competition in selling. the imperfectly competitive firm's total revenue is increasing as output increases. In Chapter 6, we learned that the demand curve for a perfect competitor is perfectly elastic and that P - MR. Because monopolistic competitors face a downward- sloping demand curve, it is no longer true that P - MR. The monopolistic competi- tor must be aware of the decline in its MR curve and the possibility of a negative MR at lower points on its demand curve. Product differentiation conducted by the monopolistic competitor can be accomplished by modifying the particular product or by advertising and sales promo- tion activities. The object is to intensify the demand for the product by distinguish- ing it from other products in the mind of the buyer. Such activities can be found inMonopolistic Competition Equilibrium in the Short Run B Marginal Average Marginal cost Average cost total tota cost cost |Profits ATCSA Loss Demand Dollars per unit E Dollars per unit Demand Marginal revenue Marginal revenue Quantity per Quantity per unit of time unit of time Figure 9-2 Monopolistic competitors also equate marginal cost and marginal revenue. The difference between the demand curve, which also represents average revenue, and the average total cost curve represents the average profit or loss per unit. Multiplying this difference by the quantity supplied (Oss) gives us the economic profit (A) or loss (8) for the business in the short run. most markets in this country. The better the business i product differentiation, the greater its influence on product price. Short-Run Equilibrium The equilibrium values for price and quantity under mo- nopolistic competition in the short run are determined by the intersection of the marginal cost curve and the marginal revenue curve. In Figure 9-2, this intersection occurs at point E, suggesting a level of output in the short run of quantity QSR. The business then sets the price it charges for its differentiated product by reading up to the demand curve and over to the price axis. From Figure 9-2, we see the monopolis- tic competitor will charge price Peg in the current period. The gap between the demand curve (D) and the average total cost curve at output QsR indicates the business achieved either an economic profit or a loss in the current period. If price exceeds average total costs, as it does in Figure 9-24, an eco- nomic profit exists in the current period. If price is less than average total costs (i.e., the demand curve lies below ATC), as it does in Figure 9-23, an economic loss is incurred. The existence of profits (losses) would result in the entry (exit) of additional monopolistic competitors over time. Long-Run Equilibrium Additional entrants to the market when economic profits exist would shift the demand curve downward (decrease average revenue) and lower profits and possibly even create losses. Monopolistic competitors exiting the market when economic losses exist will shift the demand curve upward (increase average rev- enue) and reduce losses and perhaps create economic profits. Figure 9-3 suggests that the monopolistic competitor has reached its long-run equilibrium. How can we tell? There is no gap between the demand curve and the average total cost curve at Q LR in Figure 9-3, which means that there are no economic profits that would attract other monopolistic competitors into the market and there are no losses that would cause some competitors to leave the market. Note that the firm is still equating marginal cost to marginal revenue at point E. Is the equilibrium quantity here less than what a business would have supplied under perfect competition? The answer is yes. Note in Figures 9-2 and 9-3 that the monopolistic competitor chooses to operate to the left of the minimum point on theCHAPTER NINE MARKET EQUILIBRIUM AND PRODUCT PRICE: IMPERFECT COMPETITION e 9-3 Monopolistic Competition in the Long Run e point where the opolistic competitor is Average ating at OUR average total cost que will equal average cost, indicating that average profits and age losses have been Marginal minated. cost PUR Dollar per unit Demand Marginal revenue Quantity per unit of time average total cost curve. You will recall that the minimum point on the ATC curve represents the long-run equilibrium output level for a perfectly competitive firm. Monopolistic competition therefore is less efficient than perfe Than perfect competition from the viewpoint of consumers. The market price is higher and output is lower than that occurring under perfect competition. Deciding whether this trait is unde- sirable for society, however, depends on whether we want a marketplace with an undifferentiated or a standardized product. Do we all want to wear white shirts and brown shoes? The fashion industry certainly hopes not. Also, do we all want to eat a certain brand of vanilla ice cream and a specific brand of white bread? The market- place has shown a preference for differentiated products, even if it means paying a higher price. In fact, most of the food and fiber products we purchase are supplied by monopolistic competitors. Many businesses in the United States spend large sums of money annually in an effort to differentiate their product in the eyes of the consumer. In Table 9-2, the top The conditions of 10 advertising categories of the first 6 months of 2011 are reported. Automotive was monopolistic competition the top category with $6,870.2 million of spending in the 6-month period, followed are identical to those of by local services, financial services, miscellaneous retail and telecommunications. perfect competition except that the products sold are Note that food and candy and restaurants are number six and number nine in this no longer homogeneous. list, respectively. The dollar figure for these top 10 advertising categories amounted Product differentiation is to $41 billion for the first 6 months of 201 1. The cost associated with product dif- the key difference between ferentiation is non-trivial. monopolistic competition and perfect competition. Oligopoly Further removed from the characteristics of perfect competition in selling is the oligopoly. The economic conditions that define oligopoly are the same as those of monopolistic competition with one major exception: there are only a few sellers, each of which is large enough to have an influence on market volume and price. Oligopolists also are interdependent in their decision-making. The actions of an individual oligopolist are seen as a competitive threat to the other oligopolistsMARKET EQUILIBRIUM AND PRODUCT PRICE: IMPERFECT COMPETITION CHAPTER NINE 17 oligopolist changes its price. Note that the demand curve DD is more inelastic than the ad curve. Because oligopolists take account of the reaction of other oligopolists, there is no single demand curve facing a particular oligopolist. Oligopolies typi- cally match all price decreases by their fellow oligopolists (they do not want to be undersold), but they do not match all price increases (they want to capture a greater market share). Below point 1, where other oligopolists match the firm's price cut, the demand curve DD prevails. Above point 1, the demand curve dd will prevail because rival oligopolists will not match the firm's price increase. The kinked demand curve, given by d1D, leads to a break, or vertical discontinuity, in the marginal revenue curve at output Q. The segment between points 2 and 5 represents the magnitude of this vertical discontinuity. Shifting marginal cost (MC) curves because of tech- nological advances (downward shift from MC, to MC2) intersecting the marginal revenue curve at point 4 rather than point 3 will not change the oligopoly and quantity. In meeting demand along the lower segment of the kinked demand curve (i.e. to the right of point 1), the oligopolist will be maintaining its market share, which explains why there is a tendency for prices to remain at P.. Each oligopolist will earn an economic profit per unit of P. minus its average total cost. For a variety of reasons, including the inherent uncertainty of knowing how others will respond, oligopolists facing similar demand and cost conditions may behave in a collusive fashion (i.e., arrange to charge the same price for their output) instead of in the manner depicted in Figure 9-4. Their objective may be to maximize their joint profits. The prices and quantities observed when this situation occurs will be much the same as those charged by a single seller or monopolist. Each oligopo- list would charge price Po, produce its predetermined share of Q ,, and share in the higher level of profits. Monopoly At the opposite end of the spectrum from perfect competition in selling is the monopoly. Instead of many firms or even a few firms, there is only one seller in the market. A monopoly exists for the same reason that oligopolies exist: barriers to entry. In the case of a monopolist, however, the barriers are sufficiently high to discourage all potential competitors from attempting to enter the industry. The monopoly is similar to an oligopoly, except that the monopolist has no concern for retaliation by competitors in response to changes in pricing. The monopolist sets a price that is higher than would exist under perfect competition to maximize profits. The volume sold also is below that observed under perfect competition. Because the monopolist has no competitors, the price set is usually even higher than would occur under oligopoly. In practice, however, monopolists tend to hold the price below their profit- maximizing level to discourage both the entry of competitive firms and anti-trust "litigation. Also, the lack of competitors means that a monopolist can pass on changes in cost to consumers more easily than an oligopolist. Consequently, the prices set by monopolists tend to move closely with movements in input costs that they face in production. "Firms attempting to collude to reap monopoly profits are referred to as cartels. "The cartel members jointly establish monopoly prices and quantities and each member's share of total sales. Perhaps the most famous cartel in recent years has been OPEC (Organization of Petroleum Exporting Countries). OPEC had a dramatic impact on the world price of oil in the 1970s by restricting the amount of crude oil coming into the world market. Explicit collusion among domestic sellers, however, is in violation of anti trust laws, which we will discuss shortly.\fEffect of a Maximum Price Ceiling on a Monopolist Figure 9-11 The profit earned by a monopolist will fall if a price Marginal ceiling is instituted cost Average total cost Dollars per unit MAX MA D = Demand G Quantity par unit of time price. Therefore, PMAXE is the marginal revenue curve up to Q, units of output. At output levels that exceed Q1, the original demand curve is unchanged, so FG segment of the original marginal revenue curve associated with the ED por- tion of the demand curve is still relevant. The entire marginal revenue curve is then PMAXEFG. The marginal revenue curve is discontinuous at Q 1. Therefore, the imposition of the price ceiling of IMAX would cause the monopolist to produce Q1, charge PAX per unit, and earn a profit equal to PMAXEF. Note that by instituting a price ceiling, the government would encourage the monopolist to produce m output (Q, - QM), and charge a lower price (PuAx - P.). The profit earned by the monopolist falls from APMBC to PMAXEHI. Thus, this price regulation reduces monopoly profits and lowers price. Alternatively, a governmental regulatory agency may eliminate or reduce profit of a monopoly by assessing a lump-sum tax on the firm's operation. This lump-sum tax may be a license fee or one-time charge. In essence, this countervailing action cor- responds to a fixed tax, regardless of the level of output. This situation is exhibited in iActs to Counteract Possible Figure 9-12. Without the lump-sum tax, the monopolist would produce QM. given Advese Effects of by the intersection of marginal cost and marginal revenue at point F, charge PM per Imperfect Competition Init, and earn a profit equal to area APMBC. With the imposition of the lump-sum Legislative acts passed by Congress such as the the firm's average total cost curve shifts upward from ATC, to ATC. Clayton Act of 1914, the Hence, the monopolist under this arrangement would still produce QM and charge Packers and Stockyards Act Pu per unit. However, the profit now earned by the monopolist is reduced to area of 1921, and the Capper- EPYBT, which is less than the profit earned without the tax. Volstead Act of 1922 are vehicles designed to minimize the social costs Minimum Price of imperfect competition Countervailing measures In monopsony, the government could regulate the price of a resource purchased by including price regulation imposing a minimum price that must be paid for the resource. In the case of the and taxation, as well as resource labor, this government regulation is the minimum wage law. This counter- marketing orders and vailing action is depicted graphically in Figure 9-13. marketing agreements also exist for offsetting potential Without this minimum price regulation, the monopsonist would employ QM adverse effects of imperfect units of the resource and would pay I'M per unit. With the minimum price regulation, competition.