Market Power and Policy Effects in the Korean Infant Formula Industry - Case Study-

Transcription

1 Market ower and olicy Effects in the Korean Infant Forula Industry - Case Study-

2 1. Infant forula industry in Korea Over 90% of new-born babies are priarily fed infant forula There are only four copanies that produce infant forula and the arket share of the two largest firs is about 88% Now the infant forula industry in Korea faces two challenges: 1) Decreasing birth rate - New born babies: 610 thousand (1996) 451 thousand (2006) 2) Due to high feed costs High pressure on raising raw ilk price

3 1. Infant forula anufacturing process Infant forula anufacturing process 1. Whey protein, vitains, ineral are ixed with fluid ilk. 2. Mixture is sterilized. 3. Sterilized ilk is sprayed, dried and condensed. 4. Repetition of step 3 until liquid becoes powder. Fluid ilk is the priary aterial for infant forula.

4 2. Soe policies related to ilk Dairy Coittee - Approxiately 30% of ilk producers in Korea supply ilk at the supported price through the Korea Dairy Coittee Adinistered rice of raw ilk - Dairy coittee sets the raw ilk price by considering ilk producers producing costs and national inflation rate - This adinistered price is the reference for the contracts between private copanies and individual farers

5 2. Issues in easuring arket power Definition of Market power - Lerner index: L=(p-c)/p (L=1/ η for onopoly, L=θ / η for oligopoly) Marginal cost - SC approach assues true c is known - Iwata (1974) used estiated arginal cost - Applebau (1982) assued cost function and estiated θ Assued functional fors for cost (or MC) - Genesove and Mullin (1988): assued linear arginal cost for raw aterial price c c 0 k raw - Applebau (1982), Huang and Sexton(1996): adopted Generalized Leontief Cost function

6 3. Supply relation and arket power In the quantity copetition setting - Oligopolistic fir i s first order condition for profit axiization ( Q) ( Q ) iqi ci( qi ) i Q Estiation of arket power - Bresnahan(1982), orter(1983), Genesove and Mullin (1988), Huang, Sexton(1996)and Wolfra(1999) - Aggregated individual firs FOCs yield the supply relation c'( Q) Q - I adopt the approach of Genesove and Mullin (1988) for the MC c c 0 k ilk This assuption is siilar to the concept of fixed proportion of Shroeter(1988), Alston, Sexton and Zhang(1997) and Sexton(2000) q i

7 4. Estiation results for supply relation Estiation results c o k -θ (Q) Calculated θ R 2 Estiated Value * (3033.3) ** (3.8692) * (0.0507) Note: Supply relation is estiated with deand siultaneously The eaning of estiated k 1) All the estiates are easured by won/kg 2) If we divide 1000g of (1kg) raw ilk by the value of k (=20.983), we get 47.66

8 4. Estiation results of supply relation - continue 3) Raw ilk contains 13% of solids including 3.9% of fat, 3.5% of protein, 4.8% of lactose, and 0.78% of inerals. 4) Thus, given protein and inerals ake up 4.3% of raw ilk, y estiate of 4.8% (48g/1kg) is reasonable when a sall aount of lactose is added

9 5. Derived ark-ups for the infant forula industry

10 6. Siulation odel for an oligopoly arket An issue in the siulation odel for an oligopoly arket - How can we derive the supply side elasticities? Alston, Sexton and Zhang(1997) - They proposed a siulation odel for analyzing the effects of research benefit under iperfect copetition. - They odeled oligopoly and oligopsony power of processors. - Supply side elasticities are acquired fro the raw aterial supply function. My study doesn t assue the oligosony power of infant forula processors and thus tries to derive the elasticities directly fro the supply relation.

11 7. Siulation odel for oligopoly arket - General fraework Deand and Supply relation - Deand: ( Q) a bq cz ( Q; c) - Supply relation:, c is arginal cost Linear elasticity fors dq Q d d dz Z dq dc Q c where is price elasticity of deand, is elasticity with respect to deand shifter z, is price flexibility w.r.t. quantity, and is price flexibility w.r.t. arginal cost

12 7. Siulation odel for oligopoly arket - price flexibility w.r.t. quantity in supply side If we assue arginal cost does not depend on the output, industry-level supply is defined as N c 1 c 1 ( 1 Q 1/ ) s qi '( Q) '( Q) i i i1 i i The supply relation in the oligopoly arket can be described as c θ '( Q) Q rice Flexibility w.r.t. quantity with the assuption of constant slope of deand Qs '( Q) Q s Qs Qd Q s

13 Departent of Food and Resource Econoics rice flexibility w.r.t. c ( Fro the definition of the adjusted Lerner-index, ) 7. Siulation odel for oligopoly arket - price flexibility w.r.t. c in supply side c c c 1 1* c 1 dc dc Z dz d Q dq Matrix for of the odel

14 8. Expressions for log-linear shifts in price and quantity Quantity Change dq Q 1 1 dz [ Z ( ) dc ] c rice Change d 1 1 [ dz Z dc (1 ) ] c

15 9. Siulation Results Changes of exogenous variables roportional change in Quantity (EQ) roportional change in rice (E) plus no other change % decrease in newborn babies plus 5% increase in incoe plus 10% increase in raw ilk price plus 20% increase in raw ilk price plus 5% increase in incoe plus 10% increase in raw ilk price

16 9. roportional changes in production and price according to the changes in arginal cost

17 10. Sensitivity Analysis Changes of exogenous variables 5% decrease in new-born babies plus no other changes plus 10% increase in raw ilk price plus 20% increase in raw ilk price plus 5% increase in incoe plus 10% increase in raw ilk price =-0.5 =-1 = -1.5 EQ E EQ E EQ E

18 11. Suary and Conclusions Market share of top two largest firs is over 85% in the Korean infant forula industry. Estiated arkup in infant forula industry is over 10% for the data period. However arkup shows decreasing trend If we assue the constant slope deand, the price flexibility can be expressed as the ratio of deand elasticity and a arket power paraeter. A policy-induced increase in arginal cost could yield an decrease in quantity as well as a increase in price.

19 11. Suary and Conclusions If raw ilk price is increase by 20% and the nuber of new-born babies decreases by 5%, equilibriu quantity of infant forula will be decreased by 12.06% and the price will be increased by 10.36%. In the case of less elastic deand, a ore drastic decrease in arginal cost is required to induce an increase in quantity as well as a decrease in price. Further considerations - The entire analysis critically depends on the assuption that arginal cost is a linear function of aterial price. - A siulation odel which allows a flexible arginal cost function deserves to be explored in further research.