Download Market power and food system

Our task
Answering the following questions
Why is it important to study market power in the
food system?
Market power and food system: does it really
matter?
Is there market power in the food system?
What kind of economics do we need to address
the issue of market power?
Is market power the only power which we have
to deal with?
First lecture
Introduction to competition and market power in the food
chain: basic concepts and topics.
•Definition of market power and market structure
•Perfect competition and monopoly: market
equilibria
•Market power and welfare economics – market
power and resource allocation
•The theory of industrial organization: measuring
market power
•Market structures and market power in the food
chain: some figures.
Second lecture: The theory of monopoly, monopsony and
bilateral monopoly: the standard microeconomic theory and its
limits.
Third lecture: The theory of vertical integration: the
traditional view, the transaction costs economics, the property
rights theory.
Fourth lecture: Vertical coordination in the food system:
evidences, open issues and heterodox approaches. The theory of
global value chains.
Definition of market power
In economics the ability of a firm (or group of firms) to raise and
maintain price above the level that would prevail under competition,
(i.e. above marginal costs), is referred to as market or monopoly
power. The exercise of market power leads to reduced output and
loss of economic welfare.
What is economics?
“Economics is not a clearly defined discipline. Its frontiers are
constantly changing and their definition is frequently a subject of
controversy . A commonly used definition characterizes economics
as the study of the use of limited resources for the achievement of
alternatives ends.” (Henderson and Quandt, 1958, 1971,
Microeconomic theory, a mathematical approach)
Economics:
Mainstream (orthodox) vs. Heterodox economics
Orthodox= the standard model= neoclassical economics (neoclassical
revolution at the end of the nineteenth century, Walras and the general
equilibrium model).
History of the economic thought 1
Mercantilism (dominated Western Europe from the 16th to the late-18th century)
Smith (1776 The wealth of Nations)
Classical economics (is widely regarded as the first modern school of economic
thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo,
Thomas Malthus and John Stuart Mill).
Marxian economic theory Das Kapital: Kritik der politischen Ökonomie 1867
Neoclassical revolution The body of theory later termed "neoclassical economics"
or “marginalism" was formed about 1870 to 1910 by three economists: Jeans in
England, Menger in Austria, and Walras in Switzerland. (The term "economics" was
popularized by such neoclassical economists as Alfred Marshall (1920) as a concise
synonym for "economic science" and a substitute for the earlier, broader term "political
economy" used by Smith).
History of the economic thought 2
1933 let’s talk of market power
Joan Robinson published The Economics of Imperfect Competition and
Edward Chamberlin published The Theory of Monopolistic Competition, these
two economists can be regarded as the parents of the modern study of
imperfect competition, which is an important part of modern industrial
organization.
1936 the birth of modern macroeconomics
Keynes publishes General Theory of Employment, Interest and Money The work
served as a theoretical justification for the interventionist policies Keynes
favoured for tackling a recession. The General Theory challenged the earlier
neo-classical economic paradigm, which had held that provided it was
unfettered by government interference, the market would naturally establish
full employment equilibrium. In doing so Keynes was partly setting himself
against his former teachers Marshal and Pigou.
1951, 1956 the birth of modern industrial organization.
Joe S. Bain publishes Barriers to new competition and Industrial organization
Adam Smith (1723 –1790 ) was a Scottish social philosopher and a pioneer of
political economy. One of the key figures of the Scottish Enlightenment, Smith is
the author of The Theory of Moral Sentiments and An Inquiry into the Nature and
Causes of the Wealth of Nations. The latter, usually abbreviated as The Wealth of
Nations, is considered his magnum opus and the first modern work of economics.
It earned him an enormous reputation and would become one of the most
influential works on economics ever published. Smith is widely cited as the father
of modern economics and capitalism.
The first volume of Karl Marx’s major work, Capital, was published in German in
1867. In it, Marx focused on the labour theory of value and what he considered to
be the exploitation of labour by capital. The labour theory of value held that the
value of a thing was determined by the labor that went into its production. This
contrasts with the modern understanding of mainstream economics, that the value
of a thing is determined by what one is willing to give up to obtain the thing.
The Standard model
Neoclassical economics rests on three assumptions, although
certain branches of neoclassical theory may have different
approaches:
1.People have rational preferences among outcomes that can be
identified and associated with a value.
2.Individuals maximize utility and firms maximize profits.
3.People act independently on the basis of full and relevant
information.
From these three assumptions, neoclassical economists have built
a structure to understand the allocation of scarce resources among
alternative ends—in fact understanding such allocation is often
considered the definition of economics to neoclassical theorists .
Neoclassical theory includes:
The theory of consumer behavior
The theory of the firm
The theory of market equilibrium
The theory of general market equilibrium
Neoclassical economics emphasizes equilibria, where
equilibria are the solutions of agent maximization problems.
Regularities in economies are explained by methodological
individualism, the position that economic phenomena can be
explained by aggregating over the behavior of agents
The emphasis is on microeconomics. Institutions, which
might be considered as prior to and conditioning individual
behavior, are de-emphasized.
Perfect competition
A perfectly competitive market exists when every participant is a "price taker", and no
participant influences the price of the product it buys or sells. Specific characteristics may
include:
•Infinite buyers and sellers – Infinite consumers with the willingness and ability to buy the
product at a certain price, and infinite producers with the willingness and ability to supply the
product at a certain price.
•Zero entry and exit barriers – It is relatively easy for a business to enter or exit in a perfectly
competitive market.
•Perfect factor mobility - In the long run factors of production are perfectly mobile allowing free
long term adjustments to changing market conditions.
•Perfect information - Prices and quality of products are assumed to be known to all consumers
and producers.
•Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect
mobility).
•Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where they
generate the most profit.
•Homogeneous products – The characteristics of any given market good or service do not vary
across suppliers.
•Non-increasing returns to scale - Non-increasing returns to scale ensure that there are
sufficient firms in the industry.
Properties of perfect competitive markets
•In the short term, perfectly-competitive markets are not productively
efficient as output will not occur where marginal cost is equal to average
cost, but allocatively efficient, as output will always occur where marginal
cost is equal to marginal revenue, and therefore where marginal cost
equals average revenue. In the long term, such markets are both
allocatively and productively efficient .
•Under perfect competition, any profit-maximizing producer faces a market
price equal to its marginal cost. This implies that a factor's price equals the
factor's marginal revenue product. This allows for derivation of the supply
curve on which the neoclassical approach is based (this is also the reason
why "a monopoly does not have a supply curve).
•The abandonment of price taking creates considerable difficulties to the
demonstration of existence of a general equilibrium except under other,
very specific conditions such as that of monopolistic competition.
In the short-run, it is possible for an individual firm to make an economic profit.
This situation is shown in this diagram, as the price or average revenue, denoted
by P, is above the average cost denoted by C
However, in the long period, economic profit cannot be sustained. The arrival of
new firms or expansion of existing firms (if returns to scale are constant) in the
market causes the (horizontal) demand curve of each individual firm to shift
downward, bringing down at the same time the price, the average revenue and
marginal revenue curve. The final outcome is that, in the long run, the firm will
make only normal profit (zero economic profit). Its horizontal demand curve will
touch its average total cost curve at its lowest point.
Monopoly
The equilibrium of the monopolist can be derived from profit maximization problem. Consider the
function of profit:
  RT  CT  p(Q)Q  CT (Q)
(1)
A major differences between a monopolist and a perfect competitor is that the monopolist’s price
decreases as she increases her sales. A perfect competitor accepts price as a parameter and
maximizes profit with respect to variations of his output levels; a monopolist may maximize profit with
respect to variations of either output or price.
To maximize profit set the derivative of the profit function with respect to quantity equal to zero.
d d ( p(Q )Q ) dCT (Q )


0
(2)
dQ
dQ
dQ
The first order condition for profit maximization requires that marginal revenue must equal marginal
cost
The difference between the equilibrium price pm and the marginal cost MC is called markup and is a
measure of market power exercised by the monopolist
The margin price / cost is also called the Lerner index (LI) and is a measure of market power of the
monopolist. The Lerner index is equal to:
p  MC
1
LI 

p

(3)
.
Where ε is the price demand elasticity
dQ p
 
dp Q
The (3) stems from the expression of marginal revenues
d ( p(Q )Q ) dp

Q p
dQ
dQ
(4)
Multiplying the (4) for (p/p):
 dp
 dQ Q 

 p dp Q
p 
p p
p
dQ
p

 1
p1  
 
(5)
substituting the (5) in the (2):
1

MC  p1 

 

(6)
LI 
p  MC
1

p

Effects of market power
Market power and welfare economics
The two theorems of welfare economics
There are two fundamental theorems of welfare economics. The first states
that any competitive equilibrium or Walrasian equilibrium leads to a Pareto
efficient allocation of resources. The second states the converse, that any
efficient allocation can be sustainable by a competitive equilibrium. Despite the
apparent symmetry of the two theorems, in fact the first theorem is much more
general than the second, requiring far weaker assumptions.
The first theorem is often taken to be an analytical confirmation of Adam
Smith's "invisible hand" hypothesis, namely that competitive markets
tend toward the efficient allocation of resources. The theorem supports a
case for non-intervention in ideal conditions: let the markets do the work
and the outcome will be Pareto efficient. However, Pareto efficiency is not
necessarily the same thing as desirability; it merely indicates that no one can
be made better off without someone being made worse off. Moreover a
particular pareto equilibrium is reached with respect to a given particular
income distribution; therefore any concerns about distributive equity is ruled
out.
Two important assumptions of welfare
economics
1 Once an initial distribution of resources is
provided.
2 And given that private property rights are
enforced
One of the most fundamental requirements of a
capitalist economic system—and one of the most
misunderstood concepts—is a strong system of
property rights
How do exchanges take place?
Perfect competition market hypothesis:
SPOT CONTRACT
No cost
No time
No space
Anonimously
The standard model is a autistic non-spatial and nontemporal conceptual model
Assume that production is instantaneous and producers arrive in
the market without any actual output . When the market is open
for trading, buyers and sellers begin to bid and attempt to enter
into contracts that are favorable to them.
Whenever a buyer and seller enter into contracts, they both
reserve themselves the right to recontract with any person who
makes a more favorable offer.
This process continues as long as some of the consumers who
have not been able to satisfy their demand will be induced to
raise their bids in the hope of tempting sellers away from other
consumers.
Successive offered prices are recorded and made public via an
auctioneer who is impartial observer of the trading process.
The process of recontracting continues as log
as the price announced by the auctioneer is
below the equilibrium price, i.e., as long the
quantity demanded exceeds the quantity
supplied.
When the equilibrium price is reached, neither
consumers nor producers have an incentive to
recontract any further.
Recontracting is discontinued, entrepreneurs
instantaneously produce and deliver the outputs
for which they have contracted, and the
exchange is completed.
What is a firm?
A firm is a technical unit in which commodities are
produced. His entrepreneur (owner and manager)
decides how much of and how one or more
commodities will be produced, and gains profits or
bears the loss which results from his decision.
Production function gives mathematical expression
to the relationship between the quantities of inputs
employed and the produced quantities of output.
Causes of market power
Measure of market power
Market power and market structure
Perfect
Discr Oligop
Differenti
Monopolistic
competitio
monopo iminati oly no ated
competition
n
ly
ng
diff
oligopoly
monop
olist
many
one
one
no
sì
sì
sì
sì
sì
sì
no
no
no
no
sì
Strategic
behavior
no
no (sì)
sì
sì
no
Product
omogeneity
sì
sì
sì
no
no
+o-
+o-
+o-
+o-
+o-
+o-
0
+o0
+o0
+o0
+o0
0
N. Of firms
P>MC
Free
and exit
entry
Short
profits
run
Long
profits
run
no
(sì)
Sì
(no)
Finite
number
Finite
number
Few=many