Saturday, June 8, 2013

Brazil vs USA in the corn industry.

The production agriculture is a good example of perfect competition. In my case, corn is in the perfect competition for several reasons. First of all, the number of firms is large but more than the oligopoly structure (McAlesse 2004). This is because buyers can easily find replacement sellers and sellers can generally find replacement buyers. Secondly, corn farmers are price takers. They have no control of the price of corn so there is no non-price competition against their competitors. Thirdly, corn itself is a homogenous product. One seller's product can easily be substituted by another similar product. As a result, advertising the corn does not make a difference, so the main factor influencing who the buyers are willing to buy from based on the price the seller is asking. Fourthly, the barriers to entry are low. There are limited restrictions to enter or exit the industry because they do not require advertising, control of resources, networking or strict government regulations. Fifthly, the information of the corn industry is perfect. The fact that corn is very common; the information is readily available regarding the market opportunities and production technology of the corn industry. Sixthly, resources of the industry are very mobile (Varun 2012). The resources are easy to move from this industry to an alternative use like the low capital, seeds, and scarecrows. On the other hand, the factors that influence the level of competition in corn industry are production and transportation technology. The technology used to produce corn has great impact on the market because it raises the level of competition in the industry. As for transportation, it increases the number of buyers and sellers in a market since it allows businesses to move crops around the world. Relating to the article, this explains why the corn industry is considered as "aggressive" competition between Brazil and the US for the share of the world exports because it satisfies the characteristics as a perfect competition (Agrimoney 2013).

Moving on, we look into the economic profit and revenue of perfect competition in the corn industry. Graph (a) represents the industry/market and graph (b) represents a single corn farmer. First of all, the total profit is the total revenue minus total costs (TR-TC). The price of the corn is not determined by that one corn farmer but determined by the market as a whole. If the one corn farmer set the price any higher than the equilibruim price set by the market (Pe), the one farmer cannot sell any corn. However, if the same farmer set the price any lower than then market equilibrium price, every single corn buyer would want to buy from that one corn farmer. So, the main point is the price of an individual corn farmer is perfectly elastic which explains why graph (b) is an horizontal line at the the market equilibrium price (Pe) because he has no control of the price of corn. In addition, this line is not only the demand but also represents the marginal revenue. If the corn farmer increases the input or decreases the output, it has no effect on the market price (Parkin, 2012). The sames goes for the average revenue because no matter how much he/she sells corn, it remains constant. After that, the profit maximization for perfect competition is produced at the Q in which marginal revenue equals marginal costs (MR=MC).The corn farmer increases the second additional unit because the revenue is more than the increase in costs due to that second additional unit, the firm will decide to produce the second extra unit because its profit increases. But once the MC>MR, this is when the firm suffers loss from producing additional unit mainly due to the diminishing marginal of returns (McAlesse 2004). So basically, if the corn farmer is producing below the profit maximization point he can increase profits by increasing output (MR>MC) and if he is producing above the point he can reduce the outputs it in order to increase total profit (MR<MC). Hence, ecnomic profit is maximized when MR=MC.








In the short run, when the corn farmer suffers loss, that does not mean he is necessary to shut down production (Parkin, 2012). The firm only stop production when it reaches the shutdown point (P= min AVC). It is also the point at which the MC curve intersects the AVC curve at its minimum as shown below. This is because when the firm cannot even cover the basic cost needed for production. Variable costs like material, labor, utilities, and delivery costs of corn. At this point, the firm is indifferent between producing more corn and shutting down temporarily.



Apart from that, we look further into the long run and short run in the corn industry. On the top is the corn market and on the bottom is the diagram of an individual corn farmer. At the profit maximization point (MR=MC), the price equals minimum cost and marginal cost (P=MC and minimum ATC). Since the average revenue minus average total cost equals zero (AR-ATC = 0), this means this firm is breaking even because it is not making an economic profit (Sloman 2004). Due to the fact the firm has low barriers to entry; the corn farmer is not expected to earn economic profit especially in the long run. But if the demand of corn in the market increases, consequently, the individual corn farmer will increases its output in order to gain economic profit (AR>ATC) as shown in the highlighted area. However, in the long run, because of the increase in economic profits; new firms are attracted to enter the market. So, there is an increase in the supply of corn, therefore firms experiencing profits in the short run will fall back to the original price in the long run (Pe). The same theory goes to the economic losses by corn farmers. In the short run, when exist a decrease in demand of corn, individual corn farmer will suffer economic losses (ATC>AR) so the firm will reduce the output (Sloman 2004). However in the long run, firms that continue production will eventually eliminate the losses because demand will increase due to the exiting corn farmers in the industry. The market will continue to make a series of new low (Agrimoney 2013). Relating to the article, it states that due to the dry season, safrinha corn production has decreased and might suffer losses, but this is just the short run, if safrinha were to continue their production in the long run, they will cover their losses in the short run.





In a perfect competition, each firm makes zero economic profit in the long run (Parkin, 2012). So at the price (P), each firm is producing the quantity (Q) at the lowest possible long-run average cost( P= min LRAC). This means the firm is productively efficient. Productive efficiency is when the corn farmer produces corn in the least cost manner. If the individual corn farmer wishes to produce more, it further increases the output resulting in the diseconomies of scale. There will be an increase in the per-unit costs of corn if the farmer produces beyond the point. Therefore, if they increase the output they can sell at a lower price to undercut competition. The firms all start to produce more and reduce their prices until all the firms reach constant returns to scale. That is when if you produced any more average costs would rise. At the same time, the corn farmer is allocatively efficient because the marginal social benefit equals to the marginal social cost (MSB=MSC). The demand curve is equal to the marginal utility curve, the benefit while the supply curve is equal to the marginal cost curve. Unlike the other market structures, perfect competition is very fair because no externalities exist like pollution, the distribution of income, etc (Parkin, 2012).  This means that the demand curve is also equal to the social benefit of the additional unit, while the supply curve is equal to the social cost of the additional unit. Hence, the market equilibrium, whereby demand meets supply, is also where marginal social benefit meets marginal social costs. At this point, net social benefit is maximized; this means the allocative efficiency is achieved. Under such conditions, no reorganization of production in the market will make anyone better off without making someone worse off. This indicates that the consumers of corn are willing to buy at the same level as producers are willing to sell. In perfect competition, this explains why price is equals to marginal cost(P=MC) since demand equal the price.  At the price, both consumer and producer surplus are maximized



References:

Agrimoney.com. (2013 )Corn price - Brazil crop hopes fuel downbeat talk on corn price [Online] Available at:http://www.agrimoney.com/news/brazil-crop-ideas-fuel-downbeat-talk-on-corn-price--5864.html. [Accessed 01 June 2013].
McAlesse, D. (2004) Economics for Business. Third Edition, Prentice Hall.
Parkin, M. (2012) Economics. Tenth Edition Global, Pearson.
Sloman, J. (2004) Economics for Business. Third Edition, Prentice Hall.

Varun(2012)7 most essential features of a perfectly competitive market. [Online] Available at http://www.preservearticles.com/201106178089/7-most-essential-features-of-a-perfectly-competitive-market.html. [Accessed 01June 2013].