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

2. Where is the firm’s supply curve?
P=MR=AR

3. P=MR=AR
Firm’s supply curve
starts at shut down
level of output

4. Profit maximizing firm will desire to produce where MC=MR
P=MR=AR

5. Economic losses will occur beyond output OMAX, where MC > MR
P=MR=AR

6. Building the Market Supply Curve
Market supply curve can be thought of as the horizontal summation
of the supply decisions of all firms in the market. Here, at a price
of $1.50, Gary would supply 2 tons of broccoli and Ima would
supply 1 ton, giving a market supply of 3 tons.

7. Building the Market Supply Curve+
Market supply curve can be thought of as the horizontal summation
of the supply decisions of all firms in the market. Here, at a price
of $1.50, Gary would supply 2 tons of broccoli and Ima would
supply 1 ton, giving a market supply of 3 tons.

8. Building the Market Supply Curve+ =
Market supply curve can be thought of as the horizontal summation
of the supply decisions of all firms in the market. Here, at a price
of $1.50, Gary would supply 2 tons of broccoli and Ima would
supply 1 ton, giving a market supply of 3 tons.

9. Merging Demand and Supply
Price D S PE
Market clearing price QE
Quantity

10. Merging Demand and Supply
Price D S PE QE
Quantity

11. Merging Demand and Supply
Factors that change
demand:
Other prices
Consumer income
Tastes and preferences
Wealth
Global events
Price D* D S
PE* PE QE
QE*
Quantity

12. Merging Demand and Supply
Price D S PE QE
Quantity

13. Merging Demand and Supply
Factors that change
supply:
Input costs
Government policy
Price expectations
Weather
Global events
Price D S
PE* PE
QE* QE
Quantity

14. Concept of Producer Surplus
Producer surplus is a fancy term economists
use for profit. We measure producer surplus
as the area above the supply curve and
below the market equilibrium price.

15. Concept of Producer Surplus
Producer surplus is a fancy term economists
use for profit. We measure producer surplus
as the area above the supply curve and
below the market equilibrium price.
Total economic surplus is therefore equal to
consumer surplus plus producer surplus.

16. Market Price of $4 Producer surplus at $4 is equal to area ABC F G A B
Product price
Producer surplus at $4
is equal to area ABC F G

17. Suppose Price Increased to $6…
Product price
Producer surplus at $6
is equal to area EDC F G
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18. The gain in producer surplus if the price increases from $4
is equal to area AEDB
Producers are better
off economically by
responding to this
price increase by
producing output G C F G

19. Economic Welfare Concepts
We can use the concepts of market demand
and supply to assess the effects of events
in the economy have upon the economic
well being of consumers and products in
a particular market during a specific period.
We do this using the total economic surplus
which is given by:
Total economic Consumer Producer
surplus surplus surplus = +

20. An Example of Economic Welfare Analysis
Assume a drought occurs
that results in a decrease
in supply from S to S*.
Before this happened,
consumer surplus was
area while producer
surplus was equal to
area Total economic welfare
equals area

21. An Example of Economic Welfare Analysis
After the decrease in
supply, consumer surplus
is just area 3. They lose
area 4 and area 5.
Producers gain area 4 but
lose area 7.

22. An Example of Economic Welfare Analysis
Consumers are therefore
worse off because of the
drought.
Producers are also worse
off if area 4 is less than
area 7.
Society loses area 5+7.

23. Measuring Surplus Levels$7 D
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15 S $4
Product price $1 10

24. Measuring Surplus Levels$7 D
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15 S $4
Product price
Producer surplus is
Equal to (10 x (4-1))÷2,
or $15 $1 10

25. Measuring Surplus Levels$7 D
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15 S $4
Product price
Producer surplus is
Equal to (10 x (4-1))÷2,
or $15 $1 10
Total economic surplus
is therefore $30…

26. Modeling Commodity Prices

27. Projecting Commodity Price$7 D S
D = a – bP + cYD + ePX $4
Own
price
Disposable
income
Other
prices $1 10
Page 221

28. Projecting Commodity Price$7 D S
Own
price
Input
costs $4
S = n + mP – rC $1 10
Page 221

29. Projecting Commodity Price$7 D S
D = a – bP + cYD + ePX $4
D = S
S = n + mP – rC $1 10
Substitute the demand and supply
Equations into the the equilibrium
Condition and solve for price
Page 221

30. 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

31. Market Disequilibrium

32. Market Surplus
At the price is PS,
producers would
supply QS.

33. Market Surplus
At the price is PS,
consumers would
only want QD.

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

35. At the price is PD, producers would supply QS. Market Shortage
Page 223

36. Market Shortage
Consumers
want QD at this
low price.

37. At the price is PS, a market shortage equal QD – QS exists Consumers
want QD at this
low price.

38. Adjustments to Market Equilibrium
Markets converge to equilibrium over time
unless other events in the economy occur.
One explanation for this adjustment which
makes sense in agriculture is the Cobweb
theory. This names stems from the spider
like trail the adjustment process makes.

39. Year Two Reactions Producers use last year’s price as their expected
price for year 2.
Consumers on the other
hand pay this year’s
price determined by Q2.

40. Year Three Reactions Producers now decide to produce less at the lower
expected price. This
lower quantity pushes
price up to P3 in year 3.

41. Cobweb Pattern Over Time
Market
equilibrium
The market converges to
market equilibrium where
demand intersects supply
at price PE. In some
markets, this adjustment
period may only be months
or even weeks rather than
years assumed here.

42. Market-to-Firm Linkages

43. Some Important Jargon We need to distinguish between movement
along a demand or supply curve, and shifts
in the demand or supply curve.

44. 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 “change
in demand or supply”.

45. Increase in demand
pulls up price from
Pe to Pe*
Decrease in demand
pushes price down
from Pe to Pe*

46. Increase in supply
pushed price down
from Pe to Pe*
Decrease in supply
pulls up price from
Pe to Pe*

47. Merging Demand and Supply
Price D S PE QE
Quantity

48. Firm is a “Price Taker” Under Perfect Competition
The Market
The Firm
Price
Price D S
AVC MC PE QE
OMAX
Quantity

49. If Demand Increases…… The Market The Firm Price Price S AVC MC PE QE
10 11
Quantity

50. If Demand Decreases…… The Market The Firm Price Price D S D2 AVC MC PEQE
9 10
Quantity

51. 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.

52. Market Equilibrium and Market Demand: Imperfect Competition

53. Market Structure Characteristics
Number of firms and size distribution
Product differentiation
Barriers to entry
Existing economic environment

54. 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 ( 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)

55. Firm is a “Price Taker” Under Perfect Competition
The Market
The Firm
Price
Price D S
AVC MC PE
The firm’s
Demand curve QE
OMAX
Quantity

56. 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

57. Unlike perfect competitors who face a
perfectly elastic demand curve, imperfect
competitors selling a differentiated product
benefit from a downward sloping demand
curve

58. The marginal revenue in this instance is also downward
sloping, and goes to zero at the point where total revenue peaks

59. Types of Imperfect Competitors on the Selling Side
Monopolistic competition
Oligopoly
Monopoly
Let’s start here…

60. 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

61. Short run profits. The firm
produces QSR where MR=MC at
E above, but prices its products at PSR by reading off the demand curve which reveals consumer willingness to pay

62. 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.

63. At quantity QSR, average total cost (ATCSR) is greater than PSR, which creates the loss depicted above…

64. In the long run, profits are bid away as added firms enter the market
In the long run, profits are bid away as added firms enter the market. Or losses will no longer
exists as firms exit the market. At QLR, the remaining firms are just breaking even as shown
by the lack of gap between the demand curve and ATC curve.

65. 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
Total Top 10
92.0%
$1,347.4
Total Market
$42.3 billion
$1,359.7

66. 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

67. Demand curve dd represents the
case where a single oligopolist
changes its price
Demand curve DD represents
the case when all oligopolists
move prices together and share
the market

68. Because oligopolists do not
want to be undersold, they
will match price cuts by
other oligopolists, but not
all price increases.
This gives rise to the “kinked”
demand curve beginning at
point 2. Within this kink,
shifting MC curves reflecting
technological advances will
not affect PE and QE.

69. 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.

70. Total revenue is equal
to the area 0PECQE,
which forms the blue
box to the left…
Notice the monopoly,
like the previous forms
of imperfect competition,
produces where MC=MR
(point A) and then reads
up to the demand curve
(point C) when setting
price PE.

71. Total variable costs for
the monopolist is equal
to area 0NAQE, or the
yellow box to the left.

72. Total fixed costs for the
monopolist is equal to
area NMBA, or the green
box to the left…

73. Total cost is therefore equal
to area 0MBQE, or the
green box plus the yellow
box to the left

74. Finally, the economic profit
earned by the monopolist is
equal to area MPECB, or
total revenue (blue box)
minus total costs (green box
plus yellow box).

75. Summary of imperfect competitors from a selling perspective

76. Types of Imperfect Competitors on the Buying Side
Monopsonistic competition
Oligopsony
Monopsony
Let’s start here…

77. 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

78. Buying Decisions by Perfect Competitors
Marginal revenue product
same as marginal value
product under perfect
competition.

79. Buying Decisions by Perfect Competitors

80. Buying Decisions by a Monopsonist
Monopsonist makes decesions
along the marginal revenue
product curve, which now differs
from MVP. The firm will
equate MRP=MIC at point A
and decide to buy quantity QM

81. Buying Decisions by a Monopsonist
This causes price to
fall from PPC to PM
which is referred to
as monopsonistic
explotation.

82. Equilibrium Conditions Under Alternative Combinations of Monopsony, Monopoly, and Perfect Competition

83. Case #1: Monopsonist
in buying and sole
seller of product.
Equilibrium is where
MRP=MIC at Point A.
Pricing off supply curve
gives QMM and PMM.

84. Case #2: Perfect
competition in buying
but monopoly in selling.
Equilibrium is where
MRP=Supply at Point C
which gives QPCM and
PPCM.

85. Case #3: Perfect
competition in selling
but monopsony in buying.
Equilibrium is where
MVP=MIC at Point E.
Pricing off supply curve
gives QMPC and PMPC.

86. Case #4: Perfect
competition in both selling
and buying.
Equilibrium is where
MVP=Supply at Point F
which gives QPC and
PPC.

87. 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

88. 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

89. Various segments of the livestock industry
exhibit several forms of imperfect competition.

90. Governmental Regulatory Measures
Various approaches have been taken over time to
counteract adverse effects of imperfect competition
in the marketplace. These include:
Price ceilings
Lump-sum Tax
Minimum price or floors

91. Implications of a Price Ceiling
Without regulatory interference,
the monopolist will equate MR
and MC at point C, produce QM
and charge price PM.

92. Implications of a Price Ceiling
The monopolist’s profit is
equal to APMBC or the
blue box to the left.

93. Implications of a Price Ceiling
If government imposes a
price ceiling PMAX, the
demand curve is given by
PMAXED. This is also MR
up to Q1. Beyond Q1, FG
becomes the MR curve.

94. Implications of a Price Ceiling
The price ceiling has the
effect of of causing the
monopolist to produce
more (Q1>QM) at a lower
price (PMAX<PM).

95. Implications of a Price Ceiling
The monopolist’s profit
falls to area IPMAXEH or
green box above.

96. Implications of Lump-Sum Tax
The monopolist equates
MC=MR at point F,
producing QM, and reading
up to the demand curve at
point B and charging PM.

97. Implications of Lump-Sum Tax
The lump-sum tax on the
monopolist raises the firm’s
average total costs from
ATC1 to ATC2. This lowers
the monopolist’s producer
surplus from APMBC to
EPMBT, but does not change
its level of output or price.

98. Implications of Lump-Sum Tax
The lump-sum tax on the
monopolist raises the firm’s
average total costs from
ATC1 to ATC2. This lowers
the monopolist’s producer
surplus, but does not change
its level of output or price. T
The loss in producer
surplus is area AETC
or blue box above.

99. Implications of Minimum Price
Without a minimum price,
the monopsonist would equate
MRP=MIC and employ QM
units of the input and pay PM.

100. Implications of Minimum Price
If a minimum price PF is
imposed (think of a minimum
wage rate), the monopsonist’s
MIC curve would be PFDCB.
Here the firm would actually
employ more of the resource.

101. 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