Economic theory describes perfect competition and imperfect competition. This chapter reviews the characteristics and implications of perfect competition, suggests factors that influence the level of competition a business encounters, and asks whether agricultural firms facing perfect competition may want to attempt to "break into" imperfect competition.
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The discussion has focused on the trends in agriculture, the causes for the trends, and the implications. The economic concepts of demand and supply were used to help understand these relationships. This page focuses on a review of the characteristics of competition to continue advancing our understanding of these relationships
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Production agriculture is often cited as an example of perfect competition.
- What are the characteristics of perfect competition? (required reading) What is the implication of perfect competition?
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Economic theory often describes an industry as either experiencing perfect competition or one of several forms of imperfect competition. Production agriculture is frequently used as an example of an industry with perfect competition; that is, "your wheat can substitute for my wheat." Although this may be accurate for many segments of production agriculture, a question is whether this is changing. Will production agriculture transform into an industry of less-than-perfect competition? This page presents a brief overview of perfect competition. With this background, we can consider whether the perfectly competitive nature of production agriculture may be changing.
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Characteristics of Perfect Competition
The following list summarizes the characteristics of a perfectly competitive market:
- homogenous product (one seller's product can easily be substituted with or replaced by the another seller's product),
- many buyers and sellers (buyers can easily find replacement sellers and sellers can generally find replacement buyers),
- full (readily available) information (about market opportunities and production technology),
- easy entrance and exit (i.e., easy to start or discontinue producing the product), and
- mobile resources (easy to move resources from this industry to an alternative use).
As a result of perfect competition, sellers have limited opportunity to earn an economic profit.
- Conversely, an industry that lacks one or more characteristics of perfect competition is considered to be facing imperfect competition and have an opportunity to earn more than a minimal return.
- Does this outcome suggest that a business person should intentionally try to "eliminate" one or more characteristics of perfect competition so the business has an opportunity to increase its earnings?
If production agriculture lacks one of these characteristics, which one is it and why?
As a result of perfect competition, no one person or business can control price; there is no nonprice competition (e.g., advertising your product does not make a difference; the primary factor influencing who the purchaser is willing to buy from is the price the seller is requesting); and there is limited opportunity for economic profit.
- However, some sectors of the food industry lack one or more characteristics of perfect competition (i.e., they are experiencing imperfect competition) and this offers those businesses an opportunity to earn economic profits.
- It is not uncommon to hear the suggestion that agriculture lacks "easy entrance and exit". A word of caution. Do not interpret this characteristic as if it is asking "how easy is to to initiate a profitable farm business". Instead, ask how easy is it for persons to begin producing agricultural commodities? To answer this last question, begin by considering how easy it is for persons to plant a garden.
- Compare the ease with which individuals can plant a garden to the ease with which individuals could manufacture an airplane. Which industry, in this simple example, is easier to enter: growing food (even if it is only a small quantity) versus building a machine that flies?
- Production agriculture often is not earning an economic profit because others can begin producing food if production agriculture generates an economic profit.
- Production agriculture generally lacks mobile resources; that is, it can be difficult to find an alternative use for farmland or for a tractor that is no longer needed to produce ag commodities.
- One would assume, as mentioned above, that lacking a characteristic of perfect competition opens an opportunity for the firms to act as if they are facing imperfect competition, which generally means opportunity to earn more than normal profit. However, in the case of production agriculture, lack of alternative uses for farmland, for example, can have the opposite affect. That is, lacking an alternative use, farmers will continue to use the land to produce ag commodities even if there is already excess production and declining market price for the commodities produced on the land. Therefore in the case of production agriculture, lack of alternative use can lead to a situation of continued downward pressure on commodity prices and business profit.
- What is the impact when individuals are willing to farm even though the business is generating less than a minimal level of income? Is that an example of an immobile "labor" resource? How might that "immobility" impact the overall production agriculture sector?
Factors that influence the level of competition:
- information technology increases the availability of information; e.g., market information for sellers and buyers, and information about production techniques.
- access to new production technology, whether the firm is raising livestock, baking bread, or transporting oranges. Is the new technology available to all businesses, or is the technology controlled and accessible to only some of the businesses?
- advancing transportation technology (as well as processing, storage, packaging, and other technologies) allows businesses to move products around the world thereby increasing the number of buyers and sellers in a market.
An implication of increasing competition is "reduced opportunities for profit from traditional sources" (this restates the thought that "firms in perfect competition have limited opportunity to earn an economic profit").
Competition among suppliers never hurts consumers.
Agribusiness firms often do not face perfect competition. Is this good or bad? Why?
- How would you describe imperfect competition? What is the implication (opportunity) for imperfect competition?
- Will the agriculture/food industry become a market of monopolistic competition?
- What causes an industry to become a market of monopolistic competition? See //www.unc.edu/depts/econ/byrns_web/Economicae/monocompt.html
- Are there strategies to shift production agriculture from perfect competition?
- How do these strategies relate to "consumers are becoming more specific or demanding?"
- How do these strategies relate to production technology and market information?
- What prevents producers from shifting to imperfect competition?
- Consider again the ideas of willingness to assume risk and ability to assume risk.
- How might producers overcome this barrier?
- "... various sectors of the food economy -- from producers to processors to retailers -- are more interconnected than ever before, and grow more so every day ... These contextual changes mean the United States must think differently about the agricultural and food system infrastructure." excerpt from "Food and Agricultural Policy -- Taking Stock for the New Century," page 65 of pdf file
- "Concentration and vertical integration in other agricultural sectors raises questions about the utility and validity of traditional spot-market price data, and may make it increasingly difficult to collect adequate information on such variables as production costs and farm income. There is a growing need to collect data and conduct research and analysis that will help market participants adjust to market changes and to contribute to more informed public policy deliberations relating to structural change. This will require knowing more about supply chain linkages. However, less public information is available about increasingly private market transactions." excerpt from "Food and Agricultural Policy -- Taking Stock for the New Century," page 75 of pdf file
- "Farmers once purchased inputs and sold products in arms-length transactions and largely were price takers in both markets. But, those lines are fast blurring, with differentiated products, bundled systems, and greater system coordination. Buyers and sellers of agricultural commodities and producers rely less on cash markets and more on dozens of kinds of contractual arrangements." excerpt from "Food and Agricultural Policy -- Taking Stock for the New Century," page 25 of pdf file
Kay et. al. mention that production agriculture will be more reliant on employees in the future. Why? What opportunities does this offer? What challenges does this offer?
Intentionally Eliminate One of the Characteristics of Perfect Competition?
In response, businesses try to identify and shift to markets that offer opportunities to earn additional profit. These markets are generally less than perfectly competitive -- these markets lack one or more of the characteristics of perfect competition listed above. For example, businesses try to differentiate their product ("Angus beef"), or reduce the ease of entry (must have a contract before you can sell), or develop and maintain trade/business secrets (biotechnology or consumer tastes and preferences).
Businesses try to move to less-than-perfect competition by being innovative (using information before it is general knowledge), collectively marketing to reduce the number of sellers, urging social policies that subsidize or protect market prices, differentiating their product or service by accepting added risk in exchange for a premium, or differentiating their product or service so they are not selling a "commodity."
How do these thoughts about perfect competition relate to the readings discussed as part of Trends in Agriculture?
What basic strategy might agriculture producers want to consider if they find their business is facing perfect competition? HINT -- break out of "full information" by identifying and pursuing unique production technology and/or market opportunities?
What may cause a business person not to pursue a strategy to shift their business out of perfect competition? HINT -- what are the risks associated with pursuing a unique or niche market? Do all businesses have the willingness and ability to assume the risks associated with a unique business opportunity?
NOTE -- we are back to the two "redefined" economic resources discussed in earlier materials.
Can firms vertically collaborate as a means to reduce risk associated with "breaking out of perfect competition?" Would the vertical collaborators rely on "sharing market information" as a cornerstone of their collective risk management strategy?
Impact of Trade
Information and transportation technology expand the "market," such as, expanded global trade. Is everyone positively excited about expanded trade? Consider the following categories of businesses, consumers, etc.
- Sellers/suppliers in the exporting market
- Buyers/consumers in the importing market
- Sellers/supplies in the importing market
- Buyers/consumers in the exporting market
Note: two of the categories would likely endorse and encourage expanded trade and two categories would likely want to discourage trade. Which categories would have which reaction? Why? Can you use determinants of demand and supply (as well as the concepts of demand, supply and market price) to explain each group's reaction to expanded trade?
Summary
In summary, what are some general descriptors for agriculture in the 21st century?
- How do these descriptors relate to the list of economic resources (land, labor, capital and entrepreneurial ability)? Can we discuss agriculture for the 21st century in terms of land, labor, capital, information and risk?
- What information is needed to break out of perfect competition?
- How can a manager address the risk associated with breaking out of perfect competition?
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Bottom line: will we use a collaborative approach to feed the world?