Sunday, February 20, 2011

Monopsony in factor market and monopoly in product market

What happens if traders directly purchase vegetables from farmers and then they themselves sell it in the market (and deprive of others from doing so, including the farmers)? Three things happen: (i) farmers either lose or gain; (ii) traders usually gain; and (iii) customers either lose or gain. Farmers will see gains if the traders pay high price for vegetables in the factor market (or they lose if the opposite happens). Traders mostly gain. Customers will see gains if traders purchase in bulk and sell it at a low price, largely accruing from economies of scale (or they lose if traders form a cartel and jack up prices in the product market).

What usually happens in a developing country is that traders pay low price to farmers, don’t let farmers directly sell produce in designated wholesale market set up by the government in cities, and traders form a cartel and jack up prices in the product market. Welfare of both farmers and consumers is reduced by traders by creating monopsony in factor market and monopoly in product market (they play with the quantity supplied in the product market to keep up high prices). This is what happens in Nepal and in other South Asian countries.

But, the story from Ghana is different. Traders in Ghana purchase tomatoes from rural farms and bring them to the large urban markets. A research by Robinson and Ngeleza 2011 shows that, in Ghana, the traders do operate a cartel but that farmers who sell to them receive higher prices than if they sell to the local market, even though there is little difference in quality compared with tomatoes sold to the local market.

This suggests that traders share cartel rents with these farmers, resulting in lower prices in rural areas, higher prices in the cities, and a greater constriction of total market volume. Our paper suggests that policymakers would do better to focus on the full value chain and on opening up the urban markets rather than on strengthening farmers’ bargaining power with the traders, which restricts market volumes and harms farmers unable to sell to traders.

What about the loss in welfare of consumers (due to high prices) in the product market? Does the welfare gains to farmers in the factor market offset the potential welfare losses to consumers in the product market?