Market Structure and Institutions



AGEC 6003 Week 14 Lecture Notes

Chapter 7

Market Structure and Institutions

This section will concentrate on the institutions in the agricultural marketing system that provide services, rules or facilities, their characteristics, operations and factors affection their success and performance. Coordination and integration of economic activities takes place in the marketing system through exchange. These institutions face market failures or faulty performance caused by factors such as imperfect info, high transaction costs, inadequate infrastructure, monopolies, or impediments such as gov’t policies and interventions.

Theory of Industry Organization and Performance

1. Market Classification: Four main market characteristics and forms of pure competition, monopolistic competition, oligopoly and monopoly were identified. However, the behavior or performance of these theoretical market structures were not applied to the real world until 1940 by Clark in his concept of workable competition which indicated that market structures and their behavior were deemed workably competitive if their performance was considered satisfactory by society. In 1968 Bain used Structure-Conduct-Performance model that provided empirical knowledge of food marketing systems.

2. Intra-firm Behavior: Other lines of inquiry related to industry organization and performance is intra-firm organization and management. Leibenstein developed the idea of X-inefficiency, or organization slack. This inefficiency can occur if a firm is shielded from competitive market forces, leading to lax in cost controls, growth in bureaucracies, overuse of resources and high costs. Over time, prices tend to remain higher, output lower and low technological advances. In recent years, intra-industry studies that measure effects of oligopolistic conduct on firms and their competitors has raised interest. This is called new empirical industrial organization. The conclusion from these studies yields numerous results.

3. Application of Market Classification: Theory of structure-conduct-performance of market forms or structures have provided knowledge of firm behavior as shown in Table 1 below.

a. Pure Competition: In the structure of pure competition, firms are numerous with small size such that no one firm can influence market outcome. Products are homogeneous or standardized and entry is easy. As a consequence, each firm is driven to minimize costs. Earnings are held at competitive levels and operations are at output levels where average costs are minimum. Technology advance comes from outside the structure – e.g. in agric its from public sector research. The pure competition also requires perfect knowledge on current and future market conditions.

b. Monopolistic Competition: It combines element of monopoly and pure competition and has performance results form each structure –found more in retail structures. Firms are numerous, entry easy and products are differentiated as a result the demand curve for the firm’s products slopes downwards. Competition drives demand down where unit costs are barely covered, so no excess profits prevail. That point occurs at output levels higher than the lowest point on average cost curve. Thus there tend to be excess resources tied up in this structure.

Table 1 Structure-Conduct-Performance Associated with Market Forms

Market Forms

Behavior Pure Monopolistic

Attributes Competition Competition Oligopoly Monopoly

Market Structure

# of firms Numerous Numerous Few One

Entry conditions Easy Easy Moderate Blocked

Pdt Undifferen Some Variable Unique

differentiation tiated differentiation product

Market Conduct

Recognition of Unrecognized Unrecognized Recognized None

interdependence

Optional Strategies No No Yes Yes

Market performance

Technical efficiency High Moderate Variable Variable

Progressiveness Low Low Variable Variable

Earnings Normal Normal Above normal Above normal

4. Direction of Causation in Structure-Conduct-Performance

Structure in industry influences the conduct available and expected performance.

a. External Factors: In the long run external factors in the industry, e.g. technology, gov’t rules etc can change and thus affect the entire industry structure and hence their conduct and performance.

b. Internal Factors: The dynamics of intra-firm management and conduct patterns can also affect the structure and performance – e.g. mergers, financial, selling, pricing, ads and product decisions.

5. Types of Integration and Implications to the Food Industry

Types of integration that tie together individual firms are called horizontal, vertical and conglomerate. Theses affect the structure of firms, conduct and hence performance.

a. Horizontal Integration: Refers to combination of firms that perform similar functions - e.g. the merger of 2 meat packing plants or the creation of joint venture. Horizontal integration increases market concentration, and if firms in the industry are few, it can lead to greater control of supply of products in the industry and enhance market power.

b. Vertical Integration: Its tying together 2 or more successive functions in the marketing chain for a commodity – it varies from loose contractual arrangement to outright ownership, e.g. the poultry industry where feed companies entered into contracts with growers in order to sell more feed, and then went to poultry processing and integration into hatching egg production. In recent years tight vertical integration are numerous in the agric sector where interdependence between agric input production, processing and marketing has emerged to capture efficiencies and provided market power. Problems are:

- Decision making within the vertical system is becoming more centralized and oriented towards consumer markets.

- Types of selling opportunities available to independent small firms or farms tend to decline.

- Loss of price and quantity info in the marketing system.

c. Conglomerate Integration: Refers to the branching out of business firms into other lines of activity. There are 3 main types:

- Product Extension: 2 or more different but related products are produced e.g. poultry processing and meat packing

- Market Extension: A given product is sold in 2 different market areas, e.g. milk in 2 cities distant from each other.

- Pure Conglomerate: A firm that is engaged in activities that are unrelated e.g. medicine and bread making.

Causes of conglomerate are believed to include efficiency, financial, competition, growth, economies of scale motivation. These diversifications do have implications for conduct and hence market performance e.g. a large conglomerate firm may have the potential to engage in predatory pricing to eliminate competitors in some markets because it can subsidize its losses in those markets with earnings from other markets.

6. Measures of Concentration

a. Market Share Ratio: A commonly measure of concentration in an industry is the share of the total market held by an absolute number of the largest firms in the industry or market e.g. the largest 4, 8 or 20.

Disadvantages: - its easy to construct and easy to understand.

Advantages:- covers only a portion of total market but small size firms are not covered.

b. Herfindale-Hirschman Index: A measure of concentration based on the sum of squares of market shares of firms, expressed as proportions of total market sales.

Disadvantage: This concentration index is very demanding in terms of data.

c. Gini Coefficient: It’s a measure of inequality in the distribution of firms in an industry from a hypothetical distribution of equal size firms.

Disadvantage: This index is very demanding in terms of data & is seldom used.

Note: All the 3 measures yield comparable results.

7. Problems in Performance Evaluation on Industry ( or Organizational Firms)

Many practical measures that have been used as criteria for appraising performance of industry are from the standpoint of general economic welfare of society as well as the well-being of the industry itself. Some of these performance appraisals include: profit or price-margins, production efficiency, ads costs, product characteristics and technological process.

a. Unavailable Info on Conduct: Information required for analytical verification of industry performance, especially on conduct has been unavailable.

b. Differences in Earnings: There is wide variation in earnings among firms within an industry- in pure or monopolistic competition, or oligopoly, some firms do better than others and some failed. Many external and internal factors affect structure of firms. One point of view is that high profit may come from employing new technology for efficiency rather than from market power. But there is an evidence that high concentration leads to poor performance or high profits.

c. Product Differentiation & Prices: Effects of pdt differences are common in large food manufacturing firms with strong natural brands. Such firms tend to regulate production and flows to market and thus influence prices. Large retail food chains that have large market shares in cities or market areas have influence in pricing, bargaining for food supplies and in deciding which supplies get shelf space.

d. Ads: Research has shown that high levels of ads were found to influence seller (firm) concentration in the food and tobacco industries in US. Pdt classes with no media ads decreased in concentration – i.e. the conduct of ads influence the structure of firms.

e. Technological Progress: some authors view that large size and high profits lead to more rapid technological advancement cus large firms with high profits can allocate substantial funds to R&D. An opposing view suggests that large size and highly concentrated markets tend to inhibit technological advances. In such markets firm’s attention tend to be focused protecting and building up entry barriers to keep competitors out and advertise in order to enhance their uniqueness instead of involving in technological progress.

Note: In general, evidence indicates that technological progress in most industries in the farm and food system does not require large firms or highly concentrated markets. Moreover, most inventions in agribusiness have originated in other industries or in publicly supported research laboratories. Thus the argument that high profits & concentration markets are essential for technological progress and rising productivity is not strongly supported by empirical observation.

8. Multinational Food Firms:

Defined as a firm that owns, controls and manages income producing assets in more than one country. These are mainly large firms that originate from developed countries like US, Canada or Western Europe with centralized decision making. Multinational food firms emphasize on food processing and agric commodities trading with less emphasis on food service, grocery wholesaling and retailing.

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