Transcript 10 2015-10 Market Linkages

Market Linkages: Sellers as
Buyers of Land, Labor and
Capital
The firm is the kingpin of industry but it is the network of other firms and workers who enable
management to generate a return in the overall economy.
The ways in which sellers link to their resource markets determines the feasibility of
marketing decisions for the final product as inappropriate purchasing can drive up costs and
determine the overall final selling price. The optimality rule is that the marginal revenue
product of what is sold must equal the marginal resource cost in each sub market.
There are three models that have been developed to examine the nature of this relationship
:
1. Demand Enhancement where sellers to the firm have market power derived
from technology or cultural factors by either forced compliance or market
promotion.
2. Inclusive Closed Relationships set up usually by social legislation
but always by the nature of the industry and only if transactions costs are
reduced.
3. Bilateral Monopsony / Monopoly in which single buyers buy from single
sellers.
Optimality
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Marginal Resource Cost is the addition to budgeted resource costs caused by producing the last item of output.
Marginal Revenue Product is the product of the Price and the Marginal Physical Product (the physical
technologically determined amount of output generated by the production of the last unit of output).
Market Flexibility is the gap between what is purchased and what is offered.
Marginal Resource Cost
Price of Input
What the firm wants to buy
Supply
What suppliers want
to sell to the firm
Wage/
Rent
MRP
What the firm earns in the market
Market
Flexibility
Quantity
Purchased by firms
Quantity
Offered by Suppliers
Quantity of Input
Restrictions
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Firms buy labor at a wage rate or land and capital at a rental price which is calibrated in terms of
dollars per period of time.
There is usually a market flexibility gap between what is offered and what is purchased in
recognition of the technologically determined fact that labor alone cannot produce the output
without someplace to work (land) ,certain tools to work with (capital), as well as something to work
on (basic materials).
If there is a restriction on the amount of labor that is supplied, on the amount of capital available,
the amount of land, or the amount of raw materials then the firm will be unable to operate at all if
one or more factors are eliminated but also if the restrictions eliminate the market flexibility gap.
Restrictions can come in the form of:
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Cultural usages.. i.e. holidays, forbidden products, social structures
Technological issues…i.e. anti-dated or decrepit equipment
Environmental factors… i.e. tsunamis. floods, earthquakes, monsoons
Legal factors ..trade embargoes , union legislation
Discrimination.. i.e. price and practice discrimination
Natural factors …i.e. not enough supply or running out of time.
Optimality with Restrictions
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Under restriction at wage rate A suppliers want to supply D and firms want to purchase C but only B is available
which is the wage rate that firms are unwilling to pay for that amount of input, preferring to pay wage rate E
instead. Firms believe that they are “overpaying” for the input and will take away from other input market
flexibilities in order to “stay in business”. If the Marginal Resource Cost can be pushed to the right then the
equilibrium can be re-established. For a fixed technology this is accomplished through transactions cost reduction.
Marginal Resource Cost 2
What the firm wants to buy
Restriction
Marginal Resource Cost 1
What the firm wants to buy
Price of Input
B
A
C
D
Supply
What suppliers want
to sell to the firm
Wage/
Rent
E
MRP
What the firm earns in the market
Market
Flexibility
Quantity
Demanded by firms
Quantity
Offered by Suppliers
Quantity of Input
Demand Enhancement
Forced Compliance
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When the supplier has market power and pushes the transactions costs up such that the market flexibility gap is
diminished (B:C) but the wage/rent is reduced to A . If the revenue generated at A:B is greater than the
equilibrium revenue the supplier will control the market through forced compliance.
Marginal Resource Cost 1
What the firm wants to buy
Marginal Resource Cost 2
What the firm wants to buy
Price of Input
Supply 1
What suppliers want
to sell to the firm
Wage/
Rent
B
A
C
Supply 2
What suppliers want
to sell to the firm
MRP
What the firm earns in the market
Market
Flexibility
Quantity
Purchased by firms
Quantity
Offered by Suppliers
Quantity of Input
Demand Enhancement
Market Promotion
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If the supplier can pass through the firm to the ultimate customer , the supplier can promote the consumption of
the final product and thereby move the Marginal Revenue Curve upwards to the point of removing the marginal
flexibility gap in the input market at the expense of other input markets.
Marginal Resource Cost
What the firm wants to buy
Supply
What suppliers want
to sell to the firm
Wage/
Rent
MRP 2
What the firm earns in the market
MRP 1
What the firm earns in the market
Market
Flexibility
Quantity
Purchased by firms
Quantity
Offered by Suppliers
Quantity of Input
Inclusive Closed Relationships
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If the transactions costs of an industry can be reduced by ownership of a supplier and or control of a factor market,
the market flexibility gap in one industry A can be used to cross subsidize the activity in another industry A’ by
means of Forced Compliance or Market Promotion.
Firm
Firm
A
Supplier
A
1
2
Supplier
2
A’
Forced Compliance
in the Supplier Market
1
A’
Market Promotion
in the Supplier Market
Bilateral Monopsony / Monopoly
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The Monopsony/Monopoly case is indeterminate because the monopolist wants to maximize profit A:F:G:C while
the supplier want to maximize revenue B:H:E:O
Average Cost
Target for Monopolist
Price
Average Cost
Target for Monopsonist
Promoted as :
The Input Supply Curve
F
A
B
H
G
Marginal
Revenue
C
Demand
O
Quantity
Target for Monopolist
D
E
Quantity
Target for Monopsonist
Quantity
Non Economic Actions
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In all cases of market transmission of interactions the firm may be a leader or a follower
dependent upon market structure. The more competitive an industry the more likely is the firm to
be a follower. The less competitive the more likely it is to be a leader and to chose to take its
maximum advantage either as profit in the primary market or as revenue in the secondary market.
If markets are manipulated through ownership and merger control then there is a deadweight
loss to society if the taxation system is avoided or circumvented.
If markets are manipulated so that costs are artificially structured then the trade-offs are biased
and investment decisions will be skewed so that society in general is worse off as opportunities
are missed and entrepreneurship is misguided.
Discrimination between markets, people, resources, and ideas is one technique that has been
used to manipulate cost structures and is a source of deadweight loss. It is effective in many
cases only when the target group can be separated completely and there is no possibility of an
arbitrager circumventing the discriminatory boundary.
Political action is another method of attempting to stabilize markets from time to time.
Of all of these approaches only price discrimination based on preferences is legal.
Discrimination
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Price Discrimination based on preferences for A involves paying price Pa, while for B it involves paying price Pb
and for C it involves paying price Pc. The Firm gets revenue Pa (O : Qa) + Pb (Qa : Qb) + Pc (Qb : Qc) and this
will be optimal as long as this revenue is greater than the revenue derived by treating all as if they were A , B, or C.
A
B
Price
Pa
C
Pb
Pc
O
Qa
Qb
Qc
Quantity
Market Linkages Policy Issues
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Market transmission can become very complex and as a result government have set about to
regulate the nature of markets through securities and exchange regulations, enforcement of
standards in input markets that dealing with collective bargaining, safety in handling certain
materials, practices in workplaces that support a safe and healthy working environment, social
policies that encourage harmony amongst people, land use restrictions through zoning and permit
systems. Licenses and accreditations that cover expected performance standards and also
govern liabilities.
Nevertheless markets can fall under restrictions that generate deadweight losses as well as
extreme diseconomies from time to time, in which cases governments have undertaken remedial
actions such as public private partnerships, establishing public corporations, undertaking public
works projects, and running deficits in the process.
The target of policy in this area is to attempt to channel as much market interaction as possible
through the pricing system , which if public and freely known can generate a fair and equitable
society in which freely operating citizens can maximize their own utilities by pursuing their self
interest regardless of any calamities that might come along.