A bumper harvest should be good news for farmers – but not if it drives down prices. This is the position facing many Australian farmers. After a relatively wet summer a year ago and a mild winter this year, crop yields have soared. But the prices farmers can get in wholesale markets have been so low that many have resorted to setting up their own farm shops or selling in farmers’ markets or from the backs of ‘utes’ (utility vehicles, i.e. pickup trucks) or at roadside stalls.
And the supply problem is not just one of increased domestic supply: cheap food imports, often of inferior quality, have been flooding into Australia. Increasing food exports, especially to Asia, would help Australian farmers, but here again there is competition in these markets from other countries.
The problem of increased Australian supply is even more serious for Australian farmers in areas where harvests have not been so good. Australia is a huge country and conditions, although generally favourable this year, have been poor in some areas. Here farmers face the double disaster of low output and low prices.
Australian dairy farmers too are facing problems of falling prices. Price deregulation and the monopsony power of supermarkets have driven down the price of milk and other dairy products. Since deregulation in 2000, the number of dairy farms has halved, as many smaller family farms go out of business and larger ‘industrial-scale’ farms grow.
So are there any solutions? The BBC article looks at things being done in Tasmania to help small farmers, but questions whether small farmers have much of a future more generally in Australia?
Australia’s small farmers struggling with low prices BBC News, Phil Mercer (31/10/13)
Commodity prices edge lower in October Sky News Australia (1/11/13)
Low prices spoil perfect season for Australian farmers ABC News, Eric Tlozek and Courtney Wilson (18/9/13)
Agri-businesses taking over the farm The Guardian (Australia) (6/11/13)
Commodity prices Index Mundi
Agriculture in Australia Wikipedia
Farm inputs & costs Dairy Australia
- How does the fallacy of composition relate to the ‘problem’ of good harvests?
- How price elastic is the demand for specific crops likely to be? Why may individual farmers face an elasticity of demand close to infinity?
- Illustrate the problem for small farmers in Australia with a demand and supply diagram.
- Is there any way in which farmers, either individually or collectively, can make their demand less elastic?
- Comment on the following statement by a sugar cane farmer: “We’ve got that much money tied up (in the business) we just can’t walk away”. Under what circumstances would it make sense to ‘walk away’?
- How does the monopsony power of supermarkets influence the prices farmers receive?
- Discuss ways in which the federal government in Australia could support farmers.
Most real-world markets are a long way from the perfect information setting assumed in perfectly competitive markets. Many industries therefore rely heavily on word of mouth to increase demand. This is especially true in the digital age where information can spread extremely rapidly and many websites encourage consumer ratings and reviews. Here, information becomes more and more valuable as it is shared with other people.
However, the economist Joshua Gans has suggested that traditional business models are not well suited to fully exploiting the benefits of the sharing of information. This is because, whilst enthusiastic consumers spread the word, the seller has traditionally acted as a gate-keeper, maintaining complete control over who obtains the product. The problem is that this creates a friction which can dampen momentum for the product from building.
In contrast, Gans describes a novel alternative strategy that was used by the band the XX when they released their second album earlier this year. As is becoming more and more common, the band premiered the album as an online stream. However, what was unique about the XX’s approach was that they gave the stream to a single superfan. They hoped that this chosen fan would initiate the spreading of the stream amongst other fans. After a worrying delay in which he enjoyed his monopoly ownership, this is what he eventually did. Just 24 hours later the stream had been player millions of times and the site crashed under the burden.
Of course, one reason why suppliers may need close control is to be able to charge for the product. If the sharing information must involve giving something away for free, it typically makes no commercial sense. However, Gans also points out that recommendations are more credible if the information has been costly to obtain. Otherwise, it may simply be cheap talk and therefore carry little value.
The balancing act for suppliers is therefore to introduce a hurdle cost in obtaining the information whilst trying to ensure that, once it has been passed on, the recipient encounters as little friction as possible in making use of it. Gans suggests that alternative business models can be developed which achieve this balance. If these can profitably encourage the sharing of information a win-win situation for sellers and buyers is created.
Furthermore, Gans is experimenting with selling his new book about sharing information under an example of one such model. Having bought the e-book for $4.99 you will find a coupon at the back which you can pass on to a friend or family member which allows them to buy their own copy of the book for a mere $0.99. However, as he points out, there is a potential danger to this strategy:
“All my readers could form a collective and potentially buy one copy for $4.99 and then a million for $0.99.”
He has said that he plans to be report back on how the book has sold on his blog at a later date, so it will be interesting to see whether or not the experiment was successful.
The folly of replicating the physical world HBR Blog Network, Joshua Gans (17/11/10)
A shared pricing experiment for my book Digitopoly, Joshua Gans (05/10/12)
Information wants to be…..shared O’Reilly Tools of Change for Publishing, Joe Wikert (16/10/12)
- Why will the problems described above not arise in the model of perfect competition?
- What type of industries are most likely to rely on word of mouth?
- In what type of industries is the friction described above most likely to happen?
- Describe the dangers with the strategy Gans is adopting for selling his book?
- Explain whether you think these dangers are likely to arise in practice.
- How might the business model be modified to avoid these dangers?
A modern day hindrance is spam email clogging up your inbox with, for example, offers for cheap drugs or notifications that you will inherit enough money to retire to the Bahamas. A recent paper by Justin Rao and David Reiley in the Journal of Economic Perspectives investigates the economics of spam mail (which, as I discovered, from the article gets it’s name from a Monty Python sketch). Remarkably, they quote figures suggesting that 88% of worldwide email traffic is spam. Their paper then provides a number of interesting insights into the business of spam mail.
First, given that most recipients simply delete it, why is spam mail sent out? For the benefits of sending it to exceed the costs, it must be that somebody is reading and responding to it and the costs must also be reasonably low. Rao and Reiley are able to quantify these costs and benefits. They estimate that if 8.3 million spam emails are sent, only 1.8% (approximately 150,000) will reach the intended recipients’ inboxes, with the remainder being blocked or filtered out. Of these 150,000, just 0.25% (375) are clicked on. Furthermore, these 375 clicks generate just a single sale of the advertised product which is typically sold for around $50. Assuming that free entry of spammers leads to them earning zero economic profit, this means that it costs the spammers around $50 to send the 8.3 million emails.
Second, spam mail clearly imposes a considerable negative externality on society. This includes wasted time for consumers and the costs of the extra server hardware capacity required. Rao and Reiley are also able to quantify the size of the negative externality created. First, they estimate that:
“American firms and consumers experience costs of almost $20 billion annually due to spam.”
This can then be compared to the benefits senders of spam get:
“….. we estimate that spammers and spam-advertised merchants collect gross worldwide revenues on the order of $200 million per year. Thus, the ‘externality ratio’ of external costs to internal benefits for spam is around 100:1.”
They then compare this to estimates for other negative externalities such as car pollution and conclude that the size of the negative externality from spam is significantly greater.
Finally, they also point out that it is predominantly the larger email service providers i.e. Yahoo! Mail, Microsoft Hotmail, and Google Gmail who have both the incentives and resources to fund interventions to eradicate spam. For example, in 2009 Microsoft and Pfizer (the manufacturer of Viagra which faces competition from counterfeit versions often advertised by spam) financially supported the successful operation to shut down the largest spam distributor. Clearly, such operations have large positive spillovers for email users. However, as they also discuss, anti-spam technology also increases the fixed costs of competing as an email provider and they suggest that this has contributed to the increased concentration in the market.
The unpalatable business of spam The undercover economist, Tim Harford (19/07/12)
Huge spam botnet Grum is taken out by security researchers BBC News (19/07/12)
Spammers make a combined $200 million a year while costing society $20 billion BGR, Dan Graziano (28/08/12)
- Explain why free entry results in zero economic profit.
- Explain how an increase in fixed costs can lead to an increase in concentration.
- Why does Microsoft have large incentives to eradicate spam mail?
- In what ways does the externality created by spam mail differ from other forms of advertising?
- How might government policies alter the costs and benefits of sending spam mail?
In the models of perfect and monopolistic competition, the long-run equilibrium involves firms making zero supernormal profit. The key assumption driving this outcome is that supernormal profits in the short run attract new entrants to the market.
Increased competition then results in lower prices for consumers and firms’ profits fall. Therefore, an important question is how long does it take for this process to take place?
In a recent post on the Freakonomics blog, Daniel Hamermesh describes a situation in which he was actually able to observe this adjustment process taking place amongst buskers in the centre of Madrid.
This interesting example illustrates that, at least in some cases, this process can start even before entry occurs. This is because incumbents are able to make adjustments to their existing strategies, in the case of the buskers by changing their location. Consequently, profitable opportunities start to be eroded away very quickly.
Perfect competition Chillin’Competition blog, (24/10/11)
- What are the assumptions of the model of monopolistic competition?
- What is the difference between monopolistic and perfect competition?
- Does the market for buskers fit well with the assumptions of monopolistic competition?
- In this market what might be the benefits for consumers of increased competition?
- What are the key strategies incumbents might use in this market?
- How long do you think entry might take in this market?
Last week, I posted an article about a price discriminating tactic in operation by a few firms, whereby they were charging different prices to different consumers, depending on whether or not people could speak the language. (See Entrance this way!). Following this, I had a look around to find some other pricing strategies in practice by firms. These ranged from simple price discrimination to a well-known supermarket, which, following the failure of its till system, decided to trust consumers: estimate the value of the goods in your trolley/basket, deduct 20% and that’s the amount you pay. Also, a strategy being adopted by a number of restaurants – ‘pay what you think it’s worth!’ An advertising gimmick that increased sales.
So, what’s the best pricing strategy for a firm to adopt and which factors affect this? Is it really a rational decision to offer meals, with the possibility that the guests may only be prepared to pay 1p?!
You decide how much meals are worth, restaurants tell customers Telegraph, Nina Goswami (12/06/05)
Panera café says pay what you want Associated Press, Food Inc, Christopher Leonard (18/5/10)
Pound shop forced to close after 99p store opens across the road Daily Mail Online (12/1/09)
Low cost? Not with these extras Times Online, Richard Green (17/8/08)
Cheap hotels: budget accommodation for visits to London Telegraph (25/10/10)
Budget customers call the hotel Tune BBC News, Susannah Streeter (30/8/10)
- Is it a rational decision to trust consumers and ask them to estimate the value of what’s in their trolleys?
- Why would a restaurant offer consumers the chance to pay ‘what you think it’s worth’? Under what circumstances would this incrrease the firm’s revenue?
- What are the key factors that determine the price a firm will charge for its product?
- How can we use the case in Poole, with the new 99p shop, to analyse the model of perfect competition?
- What pricing tactic is being used by the 99p shop? How could we argue that this is an example of tacit collusion?