1. ESTIMATION OF MARKET POWER IN PAKISTAN’S SUGAR INDUSTRY
Title of Research Project
Researcher’s Name
Department(s), University of Kentucky, Lexington, KY
ESTIMATION OF MARKET POWER IN PAKISTAN’S SUGAR INDUSTRY
Presenter(s): Manzoor Ahmad & Zahoor Ul Haq
Department of Economics,
Abdul Wali Khan university Mardan, Kyber PakhtunKhwa, Pakistan
Introduction
where 𝑄 𝑡 is quantity demand of refined sugar, 𝑃𝑆 𝑡 refers to the price of refined sugar, 𝑃 𝐺 𝑖 is the price of gur (substitute of sugar), 𝐿𝐼 𝑡 refers to the labor income used as a proxy for per capita monthly income and 𝑒 𝑡 𝑑 shows the random error term.
where 𝑃𝑆 𝑡 is price of sugar, 𝑀 𝐶 𝑡 is marginal cost of sugar, 𝐷 1 , 𝐷 2 , and 𝐷 3 are seasonal dummies and ε t shows others factors not included in demand model.
where 𝜃 𝑖 represents estimated conduct parameter, 𝜂 is estimated elasticity of demand and 𝛽 1 is estimated coefficient of marginal cost. Conduct parameter shows the degree of competitiveness of the market.
Figure 2: The Values of Lerner Index for Pakistan Sugar Industry during
Market power is the ability of a firm (or group of firms) to raise and maintain market price above the level that would prevail under competition. From an economic perspective, the exercise of market power is important because it can distort market outcomes away from the efficient outcomes of a competitive market and results in deadweight loss to the society, often viewed as socially undesirable. As a result, many countries have anti-trust legislation to limit the ability of a firm to accrue market power.
According to industrial organization theory, firms having oligopoly power can affect the price of a commodity to a degree determined by strategic interactions of the firm with other businesses entities. During the last five years, there is a persistent rise in the price of sugar in the country, despite declining prices in the world sugar market. This raises the question that whether persistent price increase in the domestic market could have been caused by price-setting behavior and this is the main focus of the study. The study assesses the degree of market power in Pakistan’s sugar industry.
The market outcomes in the imperfect competition are presented in figure 1. The figure consists of three curves: the marginal cost curve (MC), demand curve (D) and the marginal revenue (MR) curve. Competitive market equilibrium occurs at a point where D curve intersects the MC curve and monopoly equilibrium occurs at a point where MR curve intersects the MC curve. In perfect competition, equilibrium level of price and output are represented by 𝑃 𝐶 and 𝑄 𝐶 , respectively. On the other hand, monopoly market equilibrium occurs at 𝐸𝑀 0 . At this point the equilibrium price and output are represented by the point 𝑃 𝑀 and 𝑄 𝑀 , respectively. An oligopoly market can be occur between the two equilibrium points EC° and EM° depending on the degree of market power measured as Lerner’s Index. The index is determined by the difference between market price (P) and marginal cost (MC) weighted by market price. It ranges from a high of 1 to a low of 0, with higher numbers implying greater market power. For a perfectly competitive, P=MC and the index is 0.
Figure 1: Market outcomes in imperfect competition
𝑃𝑆 𝑡 =α+ β 1 𝑀 𝐶 𝑡 + β 2 𝐷 1 + β 3 𝐷 2 + β 4 𝐷 3 + ε t (2)
𝜃 𝑖 = 𝜂 ( 𝛽 1 −1) 𝛽 (3)
Methodology
Results
In case of equation (1), results of the unit root test show mixed order of integration. Hence, ARDL is most appropriate technique for demand analysis. Bound cointegration test confirms long-run relationship between variables. The estimated long-run coefficients of demand equation and price equation are reported in table 1.
Table 1: ARDL long run coefficients of Demand and price Equations
Price of sugar, price of gur and price of labor are statistically significant determinant of sugar consumption. The estimated price elasticity of demand is inelastic (-0.22). Lerner index for sugar industry is estimated for each year. The results reveal that there is a trend in market power of Pakistan sugar industry during (see figure 2). It depicts that sugar industry had highest market power during 2005 and lowest market power during 2012.
In the last step, we estimated the value of conduct parameter (0.045). The value shows that on average Pakistan sugar industry charge price of sugar 5 % more than marginal cost. As the empirical estimated value of the conduct parameter is quite close to competitive solution (𝜃=0) as compare to collusive behavior (𝜃=1). It is also less than Cournot-Nash solution (𝜃=0.5). So we concluded that Pakistan sugar industry does not engage in collusive behavior.
Conclusions
Our analysis show that the demand for sugar in Pakistan is inelastic.
There is positive relationship between labor Income & consumption of Sugar
There exists positive relationship between marginal cost and price of sugar
There is a positive relationship between marginal cost of sugar & price of sugar.
On average sugar industry charged price of sugar 5 percent more than marginal cost
The value of conduct parameter is close to zero, indicating that the industry does not engage in collusive behavior. .
Methodology
Policy Recommendation
There should be pure or fair competition laws and also will be putted into action the law and regulations appropriately.
With the intention of increasing competition environment in the sugar industry government should permits imports of sugar into the home economy.
Government should also provide the investment facilities to the foreigners so as to establish sugar mills in Pakistan.
Government should provide facilities for sugar mills in order to increase the exports of surplus sugar.
Future Research Direction
The estimation of oligopoly pricing rules in the sugar industry is well suited for the application of NIEO techniques. Other industries with a similar production technology and cost structure could employ to simulate the methodology further. Moreover, we employed only parametric approach to measure market power while study ignores non-parametric technique.
Methodology
References
Bettendorf, L., &Verboven, F. (1998). Competition on the Dutch Coffee Market. Research Memorandum, No. 41.
Carter, C. A., MacLaren, D., & Yilmaz, A. (1999). How Competitive is the World Wheat Market. Department of Agricultural and Resource Economics, University of California, Davis, working paper number
Corts, S. K. (1999). Conduct parameters and the measurement of market power. Journal of Econometrics, 88 (1999), 227—250.
Costigan. (2005). More Great Good Dairy-free Desserts Naturally: Sin-sational Sumptuous Treats. U.S.A: Book Publishing Company.
Economic Survey of Pakistan (2014). Pakistan: Ministry of Finance.
Econometric Analysis
The econometric analysis uses monthly data from 2005 to The analysis is carried in three steps:
Tests for unit root were carried to obtain the order of integration.
Tests for cointegration are applied to validate the long run association between variables.
Auto Regressive Distributed Lag (ARDL) models are used to estimate short and long run parameters of the model.
 The analysis requires price elasticity of demand of refined sugar, price of refined sugar and marginal cost of sugar production. These are estimated using the following three equations .
𝑄 𝑑 = 𝛼 𝑜 + 𝛼 1 𝑃𝑆 𝑖 + 𝛼 2 𝑃 𝐺 𝑖 + 𝛼 3 𝐿𝐼 𝑖 + 𝛼 4 𝐷1+ 𝛼 5 𝐷2+ 𝛼 6 𝐷3+ 𝑒 𝑖 𝑑 (1)