Blog by Carl Zulauf, Department of Agricultural, Environmental and Development Economics, Ohio State University; Gary Schnitkey, Krista Swanson, and Nick Paulson, Department of Agricultural and Consumer Economics, University of Illinois
Public discussion of fertilizer prices has become more intense and frequent, likely due in large part to the sharp increase in fertilizer prices since last year. A common theme is the potential role of monopoly pricing power. Few firms produce fertilizer. For example, North American production largely rests with 4 firms (farmdoc daily, April 5, 2022).
The basic concern is that a firm with a large individual market share may be able to raise price to garner above average, also called abnormal or monopoly, profits. Monopoly pricing power has a long history in US public policy and in economics. This article summarizes some of the key, big picture findings and thoughts from economics. The bottom lines are that it is inappropriate to equate monopoly pricing power with number of firms and that actions to address monopoly pricing power may result in higher prices.
Role of Substitutes and Entry Barriers
Availability of substitutes is a critical issue. In this use, substitutes are not different forms of the same product, such as different car models, but a distinctly different product. A prime example is the emergence of gasoline powered trucks as competition for the railroads in the early 1900s. History repeatedly underscores the importance of substitute options. A second critical issue is market entry.
If entry is easy, an attempt to raise price and create abnormal profit will bring the entry of other producers which in turn will eliminate the abnormal profit. Sustained abnormal profits requires an entry barrier(s) that prevent new firms from entering the market.
Types of Entry BarriersM
Entry barriers come in many forms. One classification involves 3 types.
• Government-enacted barriers include patents, trademarks, public expert standards, and international trade restrictions. Patents and trademarks encourage creative work by insuring income can be earned from it. Qualifying standards are minimum competency standards for doctors, beauticians, etc. They increase the likelihood of competent service. International trade restrictions can be on imports, thus affecting supply, or exports, thus affecting demand. Trade restrictions often result in a trade-off: they can mitigate unfair international competition, thus benefiting the domestic industry, but reduce domestic supply, thus increasing prices and making domestic users worse off.
• Production barriers are attributes of a firm’s technology or marketing function. They include:
– an input with no close substitute (Madagascar produces 80% or so of the world’s natural vanilla due to its unique agro-climate),
– high startup cost (high initial investment, including specialized knowledge, deters entry), and
– private qualifying standards (examples are franchises, such as McDonald’s, and private expert standards, such as American Medical Association standards for doctors).
• Firm behavior barriers are intentional manipulation of a market. They include collusion, an agreement by firms to set price by restricting supply or partitioning demand, and actions of a firm that enhance a government-enacted or production barrier.
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