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the assumption of pure competiton aec 303

the assumption of pure competiton aec 303 - (lit 3 0V MC...

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Unformatted text preview: (lit 3 \/ 0V MC: NOV/ ”’0 The Assumptions of Pure Competition Econggnists often use the theory of pure competition as a basic model for explaining the behavior of firms in an industry. At this point, it is useful to review the assumptions of the classical economic model of pure competition and assess the degree to which these assumptions might apply to farming in the United States. The model of pure competition assumes the following. 1. A large numfi’er of buyers and sellers in the industry exist. Few would feel that there are not a large number of sellers in farming. The United States Department of Agriculture (USDA) reported about 2 million farms in the United States, but farm numbers are far fewer for selected agricultural commodities. Only a few farms supply the entire nation's parsley needs, for example. The assumption of a large number of buyers may be met to a degree at a local livestock auction market or at a central grain exchange in Minneapolis or Chicago, but many agricultural products move in markets in which only a comparatively few buyers exist. The tobacco producer may face only buyers from the three or four major cigarette manufacturers, and prices are determined in an environment that is not very competitive. In the livestock sector, broiler production has been dominated in recent years by only a few major producers. 2. T he firm can sell as much as it wants at the going market price, and no single firm is large enough to influence the price for the commodity being produced. For many agricultural commodities, the farmer can sell as much as he or she wants at the market price. Farmers are price takers, not price setters, in the production of commodities such as wheat, corn, beef, and pork. However, for certain commodities, the scarcity of farms means that the producers might exert a degree of control over the price obtained. 3. T he firm can buy as much or as little of the input at the going market price, and no single firm is large enough to influence the price paid for the input. This assumption implies no discounts for buying inputs in quantity. And further, demands by the individual producer cannot raise the input price. Think how this assumption might apply or not apply in an instance whereby a farmer is making large purchases of fertilizer, or a Central Kentucky farmer requires more hired labor to produce tobacco. 4. The product is homogeneous. The homogeneity assumption implies that the product produced by all firms in the industry is identical. As a result, there is no need for advertising, for there is nothing to distinguish the output of one firm from another. For the most part, this assumption is true in farming. There is little to distinguish one producer's number 2 corn from another's number 2 com. For a few commodities, there have been some attempts at product differentiation— for example, Sunkist oranges by the growers' cooperative, and branded chicken by the individual broiler producer. Definition of a pflduct versus a commodifl. Products are branded and differentiated (Black Angus Beef; Tyson Chicken) Commodities are generic and distinguishable only by grade (US #2 Corn or #1 wheat, USDA Choice beef) at 5. T here is free entry and exit, and thus free mobility of resources (inputs or factors of production) exists both in and out of farming. The free—mobility assumption is currently seldom met in agriculture. At one time it may have been possible for a farmer to begin with very little money and a lot of ambition. Nowadays, a normal farm may very well be a business with a million dollar investment. It is difficult to see how free entry end exit can exist in an industry that may require an individual firm to have a million dollars in startup capital. Inflation over the past decade has drastically increased the startup capital requirements for farming, with resultant impacts on the mobility of resources. Free mobility of resources in linked to an absence of artificial restraints, such as government involvement. There exist a number of artificial restraints in farming. The federal government has been and continues to be involved in influencing production decisions with respect to nearly every major agricultural commodity and numerous minor commodities as well. Agricultural cooperatives have had a significant impact on production levels for commodities such as milk and oranges. Grain production in the United States is often heavily influenced by the presence of government programs. The wheat and feed grain programs are major examples. The government is involved not only in major agricultural commodities, but is also heavily involved in the economic environment for many commodities with limited production. For example, the hops producer in Washington state, or the burley tobacco producer in central Kentucky, produces in an environment in which the federal government largely determines both who will produce as well as how much each grower will produce. This is anything but competitive. 6. All variables of concern to the producer and the consumer are known with certainty. Some economists distinguish between pure competition and perfect competition. These economists argue that pure competition can exist even if all variables are not known with certainty to the producer and consumer. However, perfect competition will exist only if the producer knows not only the prices for which outputs will be sold, but also the prices for inputs. Examples of variables known with certainty: Pure Competition: 1. Production technology (repeatable over time) 2. Weather (exactly the same every year) 3. Outcomes (output or y) in response to input (x) use (i.e. How much corn will 180 pounds of nitrogen produce?) For Perfect Competition, to the above add: 4. Input prices 5. output prices Most importantly, with perfect competition the producer is assumed to have complete knowledge of the production process or function that transforms inputs or resources into outputs or commodities. Nature is assumed not to vary from year to year. Of course, this assumption is also violated in agriculture. The vagaries of nature enter into nearly everything a farmer does, and influence not only output levels, but the quantity of inputs used as well. As has been indicated, the assumptions of the purely competitive model are not very closely met by farming in the United States The next logical question is: Why retain it? The answer to this question is simple. Despite its weaknesses, the purely competitive model comes closer to representing farming than any other comprehensive model of economic behavior. An individual farm is clearly not a monopoly if a monopoly is thought of as being a model in which a single firm is the industry. Nor, for most commodities, do farmers constitute an oligopoly, if an oligopoly is defined as a model in which only a few' firms exist in a competitive environment where price and output decisions by one firm a strongly affected by the price and output decisions of other firms. Nor does farming usually meet the basic assumption of monopolistic competition, where slight differences in product prices can be maintained over the long term because individual producers are somewhat successfiil in slightly differentiating their product from products made by a rival firm. In summary, the purely competitive model has been retained as the basic model for application within agricultural economics to farming because it comes closer than any of the remaining models of competitive behavior. This does not mean that other models of competitive behavior are unimportant in the remainder of the text. Rather, reliance will be placed on the purely competitive model as the starting point for much of our analysis, with modifications made as needed to meet the particular features of the problem. ...
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