Transcript Agricultural Economics

Agricultural Economics
Lecture 2: Foundations of
Microeconomics in Agriculture
Powerpoint tranparencies from Penson, et. al. 3rd. Ed.
Where is the firm’s
supply curve?
P=MR=AR
P=MR=AR
Firm’s supply curve
starts at shut down
level of output
Profit maximizing firm
will desire to produce
where MC=MR
P=MR=AR
Economic losses will occur
beyond output OMAX, where
MC > MR
P=MR=AR
Building the Market Supply Curve
Market supply curve can be thought of as the horizontal summation
of the supply decisions of all firms in the market. Here, at a price
of $1.50, Gary would supply 2 tons of broccoli and Ima would
supply 1 ton, giving a market supply of 3 tons.
Building the Market Supply Curve
+
Market supply curve can be thought of as the horizontal summation
of the supply decisions of all firms in the market. Here, at a price
of $1.50, Gary would supply 2 tons of broccoli and Ima would
supply 1 ton, giving a market supply of 3 tons.
Building the Market Supply Curve
+
=
Market supply curve can be thought of as the horizontal summation
of the supply decisions of all firms in the market. Here, at a price
of $1.50, Gary would supply 2 tons of broccoli and Ima would
supply 1 ton, giving a market supply of 3 tons.
Merging Demand and Supply
Price
D
S
Market clearing price
PE
QE
Quantity
Merging Demand and Supply
Price
D
S
PE
QE
Quantity
Merging Demand and Supply
Price
Factors that change
S demand:
 Other prices
 Consumer income
 Tastes and preferences
 Wealth
 Global events
D*
D
PE*
PE
QE QE*
Quantity
Merging Demand and Supply
Price
D
S
PE
QE
Quantity
Merging Demand and Supply
S*
Price
D
S
PE*
PE
QE*QE
Factors that change
supply:
 Input costs
 Government policy
 Price expectations
 Weather
 Global events
Quantity
Concept of Producer Surplus
Producer surplus is a fancy term economists
use for profit. We measure producer surplus
as the area above the supply curve and
below the market equilibrium price.
Concept of Producer Surplus
Producer surplus is a fancy term economists
use for profit. We measure producer surplus
as the area above the supply curve and
below the market equilibrium price.
Total economic surplus is therefore equal to
consumer surplus plus producer surplus.
Market Price of $4
A
B
Product price
Producer surplus at $4
is equal to area ABC
F
G
Suppose Price Increased to $6…
Product price
Producer surplus at $6
is equal to area EDC
F
G
Page 217
The gain in producer surplus
if the price increases from $4
is equal to area AEDB
Producers are better
off economically by
responding to this
price increase by
producing output G
C
F
G
An Example of Economic Welfare Analysis
Assume a drought occurs
that results in a decrease
in supply from S to S*.
Before this happened,
consumer surplus was
area 3+4+5 while producer
surplus was equal to
area 6+7. Total economic welfare
equals area 3+4+5+6+7
An Example of Economic Welfare Analysis
After the decrease in
supply, consumer surplus
is just area 3. They lose
area 4 and area 5.
Producers gain area 4 but
lose area 7.
An Example of Economic Welfare Analysis
Consumers are therefore
worse off because of the
drought.
Producers are also worse
off if area 4 is less than
area 7.
Society loses area 5+7.
Measuring Surplus Levels
$7
D
S
$4
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15
Product price
$1
10
Measuring Surplus Levels
$7
D
S
$4
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15
Product price
Producer surplus is
Equal to (10 x (4-1))÷2,
or $15
$1
10
Measuring Surplus Levels
$7
D
S
$4
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15
Product price
Producer surplus is
Equal to (10 x (4-1))÷2,
or $15
$1
10
Total economic surplus
is therefore $30…
Modeling
Commodity
Prices
Projecting Commodity Price
$7
D
S
$4
D = a – bP + cYD + ePX
Own
price
Disposable
income
Other
prices
$1
10
Page 221
Projecting Commodity Price
$7
D
S
Own
price
$4
Input
costs
S = n + mP – rC
$1
10
Page 221
Projecting Commodity Price
$7
D
S
D = a – bP + cYD + ePX
D=S
$4
S = n + mP – rC
$1
10
Substitute the demand and supply
Equations into the the equilibrium
Condition and solve forPage
price221
Many Applications






Policy decisions
Commodity modeling by
brokers and traders
Credit repayment capacity
analysis by lenders
Outlook presentations by
extension economists
Planting decisions by
farmers
Herd size and feedlot
placement decisions by
livestock producers
Market Disequilibrium
Market Surplus
At the price is PS,
producers would
supply QS.
Market Surplus
At the price is PS,
consumers would
only want QD.
Market Surplus
At the price is PS,
a market surplus
equal QS – QD exists
Market Shortage
At the price is PD,
producers would
supply QS.
Page 223
Market Shortage
Consumers
want QD at this
low price.
Market Shortage
At the price is PS,
Consumers
want
a
market
QD at
shortage
this
low price.
equal
QD – QS exists
Adjustments to Market
Equilibrium
Markets converge to equilibrium over time
unless other events in the economy occur.
One explanation for this adjustment which
makes sense in agriculture is the Cobweb
theory. This names stems from the spider
like trail the adjustment process makes.
Year Two Reactions
Producers use last year’s
price as their expected
price for year 2.
Consumers on the other
hand pay this year’s
price determined by Q2.
Year Three Reactions
P3
P2
Producers now decide to
produce less at the lower
expected price. This
lower quantity pushes
price up to P3 in year 3.
Cobweb Pattern Over Time
Market
equilibrium
The market converges to
market equilibrium where
demand intersects supply
at price PE. In some
markets, this adjustment
period may only be months
or even weeks rather than
years assumed here.
Market-to-Firm Linkages
Some Important Jargon
We need to distinguish between movement
along a demand or supply curve, and shifts
in the demand or supply curve.
Some Important Jargon
We need to distinguish between movement
along a demand or supply curve, and shifts
in the demand or supply curve.
Movement along a curve is referred to as a
“change in the quantity demanded or supplied”.
A shift in a curve is referred to as a “change
in demand or supply”.
Increase in demand
pulls up price from
Pe to Pe*
Decrease in demand
pushes price down
from Pe to Pe*
Increase in supply
pushed price down
from Pe to Pe*
Decrease in supply
pulls up price from
Pe to Pe*
Merging Demand and Supply
Price
D
S
PE
QE
Quantity
Firm is a “Price Taker” Under
Perfect Competition
Price
The Market
D
S
The Firm
Price
AVC
MC
PE
QE
OMAX
Quantity
If Demand Increases……
The Market
Price
D
The Firm
D1
S
Price
AVC
MC
PE
QE
10 11
Quantity
If Demand Decreases……
The Market
Price
D2
D
The Firm
S
Price
AVC
MC
PE
QE
9 10
Quantity
Summary





Market equilibrium price and quantity
are given by the intersection of
demand and supply
Producer surplus captures the profit
earned in the market by producers
Total economic surplus is equal to
producer surplus plus consumer
surplus
A market surplus exists when the
quantity supplied exceeds the
quantity demanded.
A market shortage exists when the
quantity demanded exceeds the
quantity supplied.
Market
Equilibrium and
Market Demand:
Imperfect Competition
Market Structure Characteristics




Number of firms and
size distribution
Product
differentiation
Barriers to entry
Existing economic
environment
Perfect Competition





Up to now we have been assuming the firm and market
reflect the conditions of perfect competition… farmers
come close as anybody to meeting these conditions.
A large number of small firms (3698000 farms)
A homogeneous product (no. 2 yellow corn)
Freely mobile resources (no barriers to entry caused by
patents, etc. or barriers to exit)
Perfect knowledge of market conditions (quality outlook
information from government and university sources)
Firm is a “Price Taker” Under
Perfect Competition
Price
The Market
D
S
The Firm
Price
AVC
MC
PE
The firm’s
Demand curve
QE
OMAX
Quantity
Imperfect Competition?



Many of the markets in which farmers buy inputs and sell
their products however do not meet these conditions
This chapter initially focuses on specific types of imperfect
competitors on the selling side, who are capable of setting
the prices farmers must pay for specific inputs to
production
We then turn to imperfect competitors on the buying side,
who are capable of setting the prices farmers receive when
selling their product
Unlike perfect competitors who face a
perfectly elastic demand curve, imperfect
competitors selling a differentiated product
benefit from a downward sloping demand
curve
The marginal revenue in this instance is also downward
sloping, and goes to zero at the point where total revenue peaks
Types of Imperfect Competitors
on the Selling Side
1.
2.
3.
Monopolistic competition
Oligopoly
Monopoly
Let’s start here…
Monopolistic Competitors




Many sellers
Ability to differentiate
product by advertising
and sales promotions
Profits can exist in the
short run, but others bid
them away in the long run
Equate MC with MR, but
price off the downward
sloping demand curve
Short run profits. The firm
produces QSR where MR=MC at
E above, but prices its products at
PSR by reading off the demand
curve which reveals consumer
willingness to pay
Short run loss. The firm suffers a
loss in the current period
following the same strategy of
operating at QSR given by
MC=MR at E.
At quantity QSR, average total
cost (ATCSR) is greater than
PSR, which creates the loss
depicted above…
In the long run, profits are bid
away as added firms enter the
market. Or losses will no longer
exists as firms exit the market.
At QLR, the remaining firms are
just breaking even as shown
by the lack of gap between the
demand curve and ATC curve.
Top 10 Burger Restaurants
Rank
Brand
Market Share
Advertising
Mil. Dol.
1
McDonald’s
42.8%
$571.7
2
Burger King
20.2
407.5
3
Wendy’s
11.5
188.4
4
Hardee’s
5.7
50.5
5
Jack in the Box
3.6
51.2
6
Sonic Drive-ins
3.3
28.1
7
Carl’s Jr.
1.9
34.3
8
Whataburger
1.1
6.7
9
White Castle
1.0
10.1
10
Steak n Shake
0.9
5.7
Total Top 10
92.0%
$1,347.4
Total Market
$42.3 billion
$1,359.7
Oligopolies




A few number of sellers
Nonprice competition
between oligopolists
Match price cuts but not
price increases by fellow
oligopolists
Like monopolistic
competitors, they have
some ability to set market
prices
Demand curve dd represents the
case where a single oligopolist
changes its price
Demand curve DD represents
the case when all oligopolists
move prices together and share
the market
Because oligopolists do not
want to be undersold, they
will match price cuts by
other oligopolists, but not
all price increases.
This gives rise to the “kinked”
demand curve beginning at
point 2. Within this kink,
shifting MC curves reflecting
technological advances will
not affect PE and QE.
Monopolies





Only seller in the market
Entry of other firms is
restricted by patents, etc.
They have absolute power
over setting market price
They produce a unique
product
They can make economic
profits in the long run
because they can set
price without competition.
Total revenue is equal
to the area 0PECQE,
which forms the blue
box to the left…
Notice the monopoly,
like the previous forms
of imperfect competition,
produces where MC=MR
(point A) and then reads
up to the demand curve
(point C) when setting
price PE.
Total variable costs for
the monopolist is equal
to area 0NAQE, or the
yellow box to the left.
Total fixed costs for the
monopolist is equal to
area NMBA, or the green
box to the left…
Total cost is therefore equal
to area 0MBQE, or the
green box plus the yellow
box to the left
Finally, the economic profit
earned by the monopolist is
equal to area MPECB, or
total revenue (blue box)
minus total costs (green box
plus yellow box).
Summary of imperfect competitors from a selling perspective
Types of Imperfect Competitors
on the Buying Side
1.
2.
3.
Monopsonistic
competition
Oligopsony
Let’s start here…
Monopsony
Monopsonies




Single buyer in the market
Focus is on the marginal
input cost of purchasing
an addition unit of
resources
Will equate MVP=MIC
when making buying
decisions
As long as MVP>MIC, the
monopsonist makes a
profit
Buying Decisions by Perfect Competitors
Marginal revenue product
same as marginal value
product under perfect
competition.
Buying Decisions by Perfect Competitors
Buying Decisions by a Monopsonist
Monopsonist makes decesions
along the marginal revenue
product curve, which now differs
from MVP. The firm will
equate MRP=MIC at point A
and decide to buy quantity QM
Buying Decisions by a Monopsonist
This causes price to
fall from PPC to PM
which is referred to
as monopsonistic
explotation.
Equilibrium Conditions Under
Alternative Combinations of
Monopsony, Monopoly, and
Perfect Competition
Case #1: Monopsonist
in buying and sole
seller of product.
Equilibrium is where
MRP=MIC at Point A.
Pricing off supply curve
gives QMM and PMM.
Case #2: Perfect
competition in buying
but monopoly in selling.
Equilibrium is where
MRP=Supply at Point C
which gives QPCM and
PPCM.
Case #3: Perfect
competition in selling
but monopsony in buying.
Equilibrium is where
MVP=MIC at Point E.
Pricing off supply curve
gives QMPC and PMPC.
Case #4: Perfect
competition in both selling
and buying.
Equilibrium is where
MVP=Supply at Point F
which gives QPC and
PPC.
Monopsonistic Competitors




Many firms buying
resources
Ability to differentiate
services to producers
Differentiated services
includes distribution
convenience and location
of facilities, willingness to
provide credit or technical
assistance
P and Q determined same
as monopsonist
Oligopsonies




A few number of buyers of
a resource
Profit earned will depend
on elasticity of supply for
resource (less elastic than
monopsonistic
competition
Each oligopsonist knows
fellow oligopsonists will
respond to changes in
price or quantity it might
initiate
P and Q determined same
as monopsonist
Various segments of the livestock industry
exhibit several forms of imperfect competition.
Governmental Regulatory
Measures
Various approaches have been taken over time to
counteract adverse effects of imperfect competition
in the marketplace. These include:
Price ceilings
Lump-sum Tax
Minimum price or floors
Implications of a Price Ceiling
Without regulatory interference,
the monopolist will equate MR
and MC at point C, produce QM
and charge price PM.
Implications of a Price Ceiling
The monopolist’s profit is
equal to APMBC or the
blue box to the left.
Implications of a Price Ceiling
If government imposes a
price ceiling PMAX, the
demand curve is given by
PMAXED. This is also MR
up to Q1. Beyond Q1, FG
becomes the MR curve.
Implications of a Price Ceiling
The price ceiling has the
effect of of causing the
monopolist to produce
more (Q1>QM) at a lower
price (PMAX<PM).
Implications of a Price Ceiling
The monopolist’s profit
falls to area IPMAXEH or
green box above.
Implications of Lump-Sum Tax
The monopolist equates
MC=MR at point F,
producing QM, and reading
up to the demand curve at
point B and charging PM.
Implications of Lump-Sum Tax
The lump-sum tax on the
monopolist raises the firm’s
average total costs from
ATC1 to ATC2. This lowers
the monopolist’s producer
surplus from APMBC to
EPMBT, but does not change
its level of output or price.
Implications of Lump-Sum Tax
T
The loss in producer
surplus is area AETC
or blue box above.
The lump-sum tax on the
monopolist raises the firm’s
average total costs from
ATC1 to ATC2. This lowers
the monopolist’s producer
surplus, but does not change
its level of output or price.
Implications of Minimum Price
Without a minimum price,
the monopsonist would equate
MRP=MIC and employ QM
units of the input and pay PM.
Implications of Minimum Price
If a minimum price PF is
imposed (think of a minimum
wage rate), the monopsonist’s
MIC curve would be PFDCB.
Here the firm would actually
employ more of the resource.
Summary



Imperfect competition in the
markets which farmers buy
production inputs include
monopolistic competition,
oligopolies and monopolies
Imperfect competition in the
markets which farmers sell
production include
monopsonistic competition and
oligopsonies
Various approaches by the
government to modify/control
the effects of imperfect
competition include regulation
and taxation