Agricultural Economics Lecture 2: Foundations of Microeconomics in Agriculture Powerpoint tranparencies from Penson, et. al. 3rd. Ed

Agricultural Economics

Lecture 2: Foundations of Microeconomics in Agriculture

Powerpoint tranparencies from Penson, et. al. 3rd. Ed.

P=MR=AR

Where is the firm’ssupply curve?

Where is the firm’ssupply curve?

Firm’s supply curvestarts at shut downlevel of output

Firm’s supply curvestarts at shut downlevel of output

P=MR=AR

Profit maximizing firm will desire to producewhere MC=MR

Profit maximizing firm will desire to producewhere MC=MR

P=MR=AR

Economic losses will occurbeyond output OMAX, whereMC > MR

Economic losses will occurbeyond output OMAX, whereMC > MR

P=MR=AR

Market supply curve can be thought of as the horizontal summationof the supply decisions of all firms in the market. Here, at a priceof $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 CurveBuilding the Market Supply Curve



+




+ =


Merging Demand and Supply

Price

Quantity

D S

PE

QE

Market clearing priceMarket clearing price


Price

Quantity

D S

PE

QE


Price

Quantity

D S

PE

QE

Factors that changedemand: Other prices Consumer income Tastes and preferences Wealth Global events

Factors that changedemand: Other prices Consumer income Tastes and preferences Wealth Global events

D*

QE*

PE*


Price

Quantity

D S

PE

QE


Price

Quantity

D S

PE

QE

Factors that changesupply: Input costs Government policy Price expectations Weather Global events

Factors that changesupply: Input costs Government policy Price expectations Weather Global events

QE*

PE*

S*

Concept of Producer Surplus

Producer surplus is a fancy term economists use for profit. We measure producer surplusas the area above the supply curve andbelow the market equilibrium price.

Concept of Producer Surplus

Producer surplus is a fancy term economists use for profit. We measure producer surplusas the area above the supply curve andbelow the market equilibrium price.

Total economic surplus is therefore equal toconsumer surplus plus producer surplus.

F G

Product price

Market Price of $4Market Price of $4

A B

Producer surplus at $4is equal to area ABC

Producer surplus at $4is equal to area ABC

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F G

Producer surplus at $6is equal to area EDC

Producer surplus at $6is equal to area EDC

Product price

Suppose Price Increased to $6…Suppose Price Increased to $6…

The gain in producer surplus if the price increases from $4is equal to area AEDB

The gain in producer surplus if the price increases from $4is equal to area AEDB

F G

Producers are betteroff economically byresponding to thisprice increase byproducing output G

Producers are betteroff economically byresponding to thisprice increase byproducing output GC

An Example of Economic Welfare AnalysisAn Example of Economic Welfare Analysis

Assume a drought occursthat results in a decreasein supply from S to S*.

Before this happened,consumer surplus wasarea 3+4+5 while producersurplus was equal toarea 6+7. Total economic welfareequals area 3+4+5+6+7

Assume a drought occursthat results in a decreasein supply from S to S*.

Before this happened,consumer surplus wasarea 3+4+5 while producersurplus was equal toarea 6+7. Total economic welfareequals area 3+4+5+6+7


After the decrease insupply, consumer surplusis just area 3. They lose area 4 and area 5.

Producers gain area 4 butlose area 7.

After the decrease insupply, consumer surplusis just area 3. They lose area 4 and area 5.

Producers gain area 4 butlose area 7.


Consumers are thereforeworse off because of thedrought.

Producers are also worse off if area 4 is less than area 7.

Society loses area 5+7.

Consumers are thereforeworse off because of thedrought.

Producers are also worse off if area 4 is less than area 7.

Society loses area 5+7.

Measuring Surplus LevelsMeasuring Surplus Levels

Product price

DS

$4

10

$1

$7Consumer surplus isequal to (10 x (7-4))÷2,or $15

Consumer surplus isequal to (10 x (7-4))÷2,or $15


Product price

DS

$4

10

$1



Producer surplus isEqual to (10 x (4-1))÷2,or $15



Product price

DS

$4

10

$1





Total economic surplusis therefore $30…

Total economic surplusis therefore $30…

Modeling CommodityPrices

Projecting Commodity PriceProjecting Commodity Price

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DS

$4

10

$1

$7

D = a – bP + cYD + ePXD = a – bP + cYD + ePX

Ownprice

Ownprice

Disposableincome

Disposableincome

Otherprices

Otherprices


Page 221

DS

$4

10

$1

$7

S = n + mP – rCS = n + mP – rC

Ownprice

Ownprice

Inputcosts

Inputcosts


Page 221

D = SD = S

DS

$4

10

$1

$7

D = a – bP + cYD + ePXD = a – bP + cYD + ePX

S = n + mP – rCS = n + mP – rC

Substitute the demand and supplyEquations into the the equilibriumCondition and solve for price

Substitute the demand and supplyEquations into the the equilibriumCondition and solve for price

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 SurplusMarket Surplus

At the price is PS, producers wouldsupply QS.

At the price is PS, producers wouldsupply QS.


At the price is PS, consumers wouldonly want QD.

At the price is PS, consumers wouldonly want QD.


At the price is PS, a market surplus equal QS – QD exists

At the price is PS, a market surplus equal QS – QD exists

Market ShortageMarket Shortage

At the price is PD, producers wouldsupply QS.

At the price is PD, producers wouldsupply QS.

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Consumers want QD at thislow price.





At the price is PS, a market shortage equal QD – QS exists

At the price is PS, a market shortage 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 whichmakes sense in agriculture is the Cobwebtheory. This names stems from the spiderlike trail the adjustment process makes.

Year Two ReactionsYear Two Reactions

Producers use last year’sprice as their expectedprice for year 2.

Consumers on the otherhand pay this year’s price determined by Q2.

Producers use last year’sprice as their expectedprice for year 2.

Consumers on the otherhand pay this year’s price determined by Q2.

Year Three ReactionsYear Three Reactions

P2

P3

Producers now decide toproduce less at the lowerexpected price. Thislower quantity pushesprice up to P3 in year 3.

Producers now decide toproduce less at the lowerexpected price. Thislower quantity pushesprice up to P3 in year 3.

Cobweb Pattern Over TimeCobweb Pattern Over Time

Marketequilibrium

Marketequilibrium

The market converges tomarket equilibrium wheredemand intersects supplyat price PE. In some markets, this adjustmentperiod may only be monthsor even weeks rather thanyears assumed here.

The market converges tomarket equilibrium wheredemand intersects supplyat price PE. In some markets, this adjustmentperiod may only be monthsor even weeks rather thanyears 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 “changein demand or supply”.

Increase in demandpulls up price from Pe to Pe*

Increase in demandpulls up price from Pe to Pe*

Decrease in demandpushes price downfrom Pe to Pe*

Decrease in demandpushes price downfrom Pe to Pe*

Increase in supplypushed price down from Pe to Pe*

Increase in supplypushed price down from Pe to Pe*

Decrease in supplypulls up price from Pe to Pe*

Decrease in supplypulls up price from Pe to Pe*


Price

Quantity

D S

PE

QE

Firm is a “Price Taker” Under Perfect Competition Price

Quantity

D S

PE

QE

Price

OMAX

AVC MC

The MarketThe Market The FirmThe Firm

If Demand Increases……

Price

Quantity

D S

PE

QE

Price

AVC MC


10 11

D1

If Demand Decreases……

Price

Quantity

D S

PE

QE

Price

AVC MC


9 10

D2

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.

MarketEquilibrium 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

Quantity

D S

PE

QE

Price

OMAX

AVC MC


The firm’sDemand curve

The firm’sDemand curve

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, imperfectcompetitors selling a differentiated productbenefit from a downward sloping demandcurve

Unlike perfect competitors who face a perfectly elastic demand curve, imperfectcompetitors selling a differentiated productbenefit from a downward sloping demandcurve

The marginal revenue in this instance is also downwardsloping, and goes to zero at the point where total revenue peaks

The marginal revenue in this instance is also downwardsloping, and goes to zero at the point where total revenue peaks

Types of Imperfect Competitors on the Selling Side1. Monopolistic competition

2. Oligopoly

3. MonopolyLet’s start here…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 firmproduces QSR where MR=MC atE above, but prices its products at PSR by reading off the demand curve which reveals consumer willingness to pay

Short run profits. The firmproduces QSR where MR=MC atE 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.

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…

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 longerexists as firms exit the market. At QLR, the remaining firms are just breaking even as shownby the lack of gap between the demand curve and ATC curve.

In the long run, profits are bid away as added firms enter the market. Or losses will no longerexists as firms exit the market. At QLR, the remaining firms are just breaking even as shownby 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 representsthe case when all oligopolistsmove prices together and sharethe market

Demand curve DD representsthe case when all oligopolistsmove prices together and sharethe market

Demand curve dd represents the case where a single oligopolist changes its price

Demand curve dd represents the case where a single oligopolist changes its price

Because oligopolists do notwant to be undersold, they will match price cuts by other oligopolists, but notall price increases.

This gives rise to the “kinked”demand curve beginning atpoint 2. Within this kink,shifting MC curves reflectingtechnological advances willnot affect PE and QE.

Because oligopolists do notwant to be undersold, they will match price cuts by other oligopolists, but notall price increases.

This gives rise to the “kinked”demand curve beginning atpoint 2. Within this kink,shifting MC curves reflectingtechnological advances willnot 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 equalto the area 0PECQE,which forms the bluebox to the left…

Notice the monopoly,like the previous formsof imperfect competition,produces where MC=MR(point A) and then reads up to the demand curve (point C) when setting price PE.

Total revenue is equalto the area 0PECQE,which forms the bluebox to the left…

Notice the monopoly,like the previous formsof 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 forthe monopolist is equalto area 0NAQE, or theyellow box to the left.

Total variable costs forthe monopolist is equalto area 0NAQE, or theyellow box to the left.

Total fixed costs for themonopolist is equal toarea NMBA, or the greenbox to the left…

Total fixed costs for themonopolist is equal toarea NMBA, or the greenbox to the left…

Total cost is therefore equalto area 0MBQE, or thegreen box plus the yellowbox to the left

Total cost is therefore equalto area 0MBQE, or thegreen box plus the yellowbox to the left

Finally, the economic profitearned by the monopolist isequal to area MPECB, ortotal revenue (blue box) minus total costs (green boxplus yellow box).

Finally, the economic profitearned by the monopolist isequal to area MPECB, ortotal revenue (blue box) minus total costs (green boxplus yellow box).

Summary of imperfect competitors from a selling perspectiveSummary of imperfect competitors from a selling perspective

Types of Imperfect Competitors on the Buying Side1. Monopsonistic

competition

2. Oligopsony

3. Monopsony Let’s start here…Let’s start here…

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

Marginal revenue product same as marginal value product under perfectcompetition.

Marginal revenue product same as marginal value product under perfectcompetition.

Buying Decisions by Perfect CompetitorsBuying Decisions by Perfect Competitors

Buying Decisions by Perfect CompetitorsBuying Decisions by Perfect Competitors

Buying Decisions by a MonopsonistBuying Decisions by a Monopsonist

Monopsonist makes decesionsalong the marginal revenueproduct curve, which now differsfrom MVP. The firm willequate MRP=MIC at point Aand decide to buy quantity QM

Monopsonist makes decesionsalong the marginal revenueproduct curve, which now differsfrom MVP. The firm willequate MRP=MIC at point Aand decide to buy quantity QM

Buying Decisions by a MonopsonistBuying Decisions by a Monopsonist

This causes price tofall from PPC to PM which is referred toas monopsonisticexplotation.

This causes price tofall from PPC to PM which is referred toas monopsonisticexplotation.

Equilibrium Conditions UnderAlternative Combinations ofMonopsony, Monopoly, andPerfect Competition

Case #1: Monopsonist in buying and sole seller of product.

Equilibrium is whereMRP=MIC at Point A.Pricing off supply curvegives QMM and PMM.

Case #1: Monopsonist in buying and sole seller of product.

Equilibrium is whereMRP=MIC at Point A.Pricing off supply curvegives QMM and PMM.

Case #2: Perfect competition in buying but monopoly in selling.

Equilibrium is whereMRP=Supply at Point Cwhich gives QPCM and PPCM.

Case #2: Perfect competition in buying but monopoly in selling.

Equilibrium is whereMRP=Supply at Point Cwhich gives QPCM and PPCM.

Case #3: Perfect competition in selling but monopsony in buying.

Equilibrium is whereMVP=MIC at Point E.Pricing off supply curvegives QMPC and PMPC.

Case #3: Perfect competition in selling but monopsony in buying.

Equilibrium is whereMVP=MIC at Point E.Pricing off supply curvegives QMPC and PMPC.

Case #4: Perfect competition in both selling and buying.

Equilibrium is whereMVP=Supply at Point Fwhich gives QPC and PPC.

Case #4: Perfect competition in both selling and buying.

Equilibrium is whereMVP=Supply at Point Fwhich 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 industryexhibit several forms of imperfect competition.

Various segments of the livestock industryexhibit several forms of imperfect competition.

Governmental Regulatory Measures

Various approaches have been taken over time to counteract adverse effects of imperfect competitionin the marketplace. These include:

Price ceilings

Lump-sum Tax

Minimum price or floors

Implications of a Price CeilingImplications of a Price Ceiling

Without regulatory interference, the monopolist will equate MR and MC at point C, produce QM

and charge price PM.

Without regulatory interference, the monopolist will equate MR and MC at point C, produce QM

and charge price PM.

Implications of a Price Ceiling Implications of a Price Ceiling

The monopolist’s profit isequal to APMBC or theblue box to the left.

The monopolist’s profit isequal to APMBC or theblue box to the left.


If government imposes aprice ceiling PMAX, thedemand curve is given byPMAXED. This is also MRup to Q1. Beyond Q1, FGbecomes the MR curve.

If government imposes aprice ceiling PMAX, thedemand curve is given byPMAXED. This is also MRup to Q1. Beyond Q1, FGbecomes the MR curve.


The price ceiling has theeffect of of causing themonopolist to producemore (Q1>QM) at a lowerprice (PMAX<PM).

The price ceiling has theeffect of of causing themonopolist to producemore (Q1>QM) at a lowerprice (PMAX<PM).

Implications of a Price Ceiling Implications of a Price Ceiling

The monopolist’s profitfalls to area IPMAXEH orgreen box above.

The monopolist’s profitfalls to area IPMAXEH orgreen box above.

Implications of Lump-Sum TaxImplications of Lump-Sum Tax

The monopolist equatesMC=MR at point F, producing QM, and readingup to the demand curve atpoint B and charging PM.

The monopolist equatesMC=MR at point F, producing QM, and readingup to the demand curve atpoint B and charging PM.

Implications of Lump-Sum Tax Implications of Lump-Sum Tax

The lump-sum tax on themonopolist raises the firm’saverage total costs fromATC1 to ATC2. This lowersthe monopolist’s producersurplus from APMBC toEPMBT, but does not changeits level of output or price.

The lump-sum tax on themonopolist raises the firm’saverage total costs fromATC1 to ATC2. This lowersthe monopolist’s producersurplus from APMBC toEPMBT, but does not changeits level of output or price.

Implications of Lump-Sum TaxImplications of Lump-Sum Tax

The lump-sum tax on themonopolist raises the firm’saverage total costs fromATC1 to ATC2. This lowersthe monopolist’s producersurplus, but does not changeits level of output or price.

The lump-sum tax on themonopolist raises the firm’saverage total costs fromATC1 to ATC2. This lowersthe monopolist’s producersurplus, but does not changeits level of output or price.The loss in producer

surplus is area AETCor blue box above.

The loss in producersurplus is area AETCor blue box above.

T

Implications of Minimum PriceImplications of Minimum Price

Without a minimum price,the monopsonist would equateMRP=MIC and employ QM

units of the input and pay PM.

Without a minimum price,the monopsonist would equateMRP=MIC and employ QM

units of the input and pay PM.

Implications of Minimum Price Implications of Minimum Price

If a minimum price PF is imposed (think of a minimum wage rate), the monopsonist’sMIC curve would be PFDCB.Here the firm would actuallyemploy more of the resource.

If a minimum price PF is imposed (think of a minimum wage rate), the monopsonist’sMIC curve would be PFDCB.Here the firm would actuallyemploy 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

Documents

Agricultural Economics Lecture 2: Foundations of Microeconomics in Agriculture Powerpoint tranparencies from Penson, et. al. 3rd. Ed