Downstream Market Equilibrium and Optimal Policy for the Conventional Food Distribution System in Vietnam: An Industrial Organization Analysis45298

Downstream Market Equilibrium and Optimal Policy for the Conventional Food Distribution System in Vietnam: An Industrial Organization Analysis Ngo Chi Thanh(1)*, (1) Hong Duc University, Thanh Hoa, Vietnam * Correspondence: ngochithanh@hdu.edu.vn Abstract: The theory of imperfect competition has largely focused on the growing of market power and the competition in agricultural market Based on the context of Vietnam, this paper propose a industrial organization model for developing countries in the particular case of oligopoly downstream market power in the conventional food distribution system The strategy of this paper is to borrow several arguments from imperfect competition applied in agricultural economics We assume that middlemen have market power at downstream of the food system A small scale farmer is characterized by production function while the consumer behavior is defined by a discrete choice model; the inverse demand function is introduced associated to Mussa-Rosen type Based on such consideration, we study the quantity flow from small farmers to consumers by mean of Cournot competition and address the question of optimal the best choice of land reform policy by productivity shock at downstream market equilibrium Keywords: Food system; Industrial organization; Downstream Market Power; Vietnam Economics Introduction In many developing countries, for example in Vietnam, the traditional food distribution system becomes very important for delivery food to the cities (Maruyama 2010) According to General Statistics of Vietnam (GSO, 2018), as of 31st December 2018, there were 8,475 markets nationwide This conventional system basically moves products from small farmers to consumers through several intermediaries (e.g collectors, transporters, wholesales) called middlemen and then to the retail sector (e.g street markets, organized bazaar, frog market) Since most producers of this products are small farmers who only exploit small lands (for instance, among the total number of households using agricultural land, 36.1% of them were using under 0.2 per household; only 2.3% of them were using 5.0 or more per household (GSO, 2018), the middlemen becomes a crucial factor to delivering products from farmer to cities and urban areas (Moustier 2007; Moustier et al 2010) Despite the fact that middlemen are the important factor to distribute products from farmers to the consumers, they are always thought to gain excessive profit from farmers by their market power (Merel et al 2009; Myers et al 2010); Based on this observation, the objective of this paper address the question of how market power of middlemen affecting to the wealth of farmers and consumers In more precisely, the paper study the case of downstream market power which linked to the context of Vietnam in the situation that: at the local town level, there are a big number of farmers producing foods, and there is also many middlemen buying these products from farmers In this situation, middlemen not have oligopsony market power, but they have oligopoly power since these products are sold at their small shops Since the imperfect competition are largely considerable in the food market (McCorriston 2002; Sexton and Lavoie 2001; Myer et al 2010) The strategy of this paper is to borrow several arguments based on the theory of imperfect competition We propose theoretical model of middlemen behavior in downstream market power We assume that middlemen have market power in the downstream of the food system Small farmers are characterized by a production function and the consumer’s behavior is defined by a discrete choice model The inverse demand function is introduced associated to Mussa – Rossen type (Mussas and Rossen 1978) Since we introduce Cournot competition, we assume that the middlemen are able to anticipate the effect of their demand on the prices that should be given at market Under such consideration, we construct the model of middlemen in downstream of the traditional food distribution system for developing countries typically based on the context of Vietnam Under such consideration, we study the downstream market equilibrium to analyze quantity trade, price and the wealth of both producers and consumers Based on the optimal profit problem of middlemen in market competition, we analyzed the behavior of middlemen at market equilibrium for the case of downstream market power The result of trade quantity, the price paid to farmers and paid by consumers and the profit of both farmers and middlemen at market equilibrium are point out to analyze the situation These results give us opportunity to analyze the behavior of middlemen at downstream of the food system We show that, since middlemen have downstream market power, there is always a distortion with respect to perfect competition in the price paid to farmers and sell to consumers As consequence, the wealth of farmers becomes lower even consumers buying foods at higher price Since lands are small and fragmentation (Marsh et al 2006; Pham et al 2007; Nguyen 2012; GSO, 2018), we construct model of land reform in order to make small land exploited and labor force used more frequently and effectively for the expectation of reducing the production cost and improving productivity We directly introduce the parameter of land reform in the food production of the farmer Given from this intermediate result, we therefore can study the effect of land reform on the prices and quantities, at the same time, we can recognize how the wealth of farmers and consumers changed in this case of market competition We finally address the question of the optimal the best choice of land reform policy for the case of downstream market power For the subject of middlemen behavior and their market power, we can review in several literatures For instance, Merel et al (2009) argued that, high transportation cost can be important reason leading to middlemen market power Master (2007, 2008) show that when the middlemen present in the market, they are welfare reducing, however, they can beneficial to society Rubinstein and Wholinsky (1987) studied a model of a market with sellers, buyers and middlemen, which highlighted the relation between the trading and the distribution of the gains from trade Related to the issue of middlemen market power in food markets, Thanh (2017; 2018) proposed industrial organization model for developing countries These researches focus on the case of upstream and the case of both market side of the traditional food distribution system However, the question of middlemen behavior at downstream market equilibrium has not yet addressed This remaining in fact is the interesting case of industrial organization linked to the context of Vietnam That is the reason why this paper aims at studying the middlemen behavior in downstream market equilibrium of food market and proposing policy implication in order to intervene to market imperfect competition This paper contributes to the literatures on the food distribution system by studying the middlemen behavior and their downstream market power in the food market This work opens the prospective for research to study the policy for controlling market imperfect competition and improving the wealth of both farmers and consumers Methodology 2.1 Imperfect competition framework It is largely recognized that imperfect completion is important in agricultural economics (Sexton and Lavoie 2001; McCorriston 2002; Myer et al 2010) Therefore, this paper strategy is to borrow several augments based on the theory of imperfect competition applied in agricultural economics In fact, the concept of imperfect competition has largely focus on the growing of market power and the competition in agricultural market Since the objective of this paper is to understand how market behaves and competes, this framework becomes very important tool for us to not only understand the situation but also analyze the situation of food distribution system based on imperfect competition approach For the case of Vietnam, the role of imperfect competition in the analysis of the food market competition especially becomes more important since there is market imperfect competition linked to the context of Vietnam For instance: (i) The number of small scale farmers is very large to have only small market power or(ii) Foods is produced in different locations which are far from cities and urban areas where consume a big quantity of foods (Wiersinga et al 2004) As consequence, farmers face with high transaction cost and therefore have very small market power to bargain the price with the intermediaries who transport their products to final consumers From that point of view, this paper applied the theory of imperfect competition to address the question of downstream market power of intermediaries in the Vietnam conventional food distribution 2.2 Theoretical assumption of the model The assumption and denotation of the industrial organization model is introduced as in (Thanh 2017, 2018) Let us briefly recall some crucial characteristics of the assumption and denotation In the case of Vietnam, the food system is offended characterized by small farmers, and two distribution channels which compete: a traditional and a modern one Most of the foods are transported to the market with two wheel vehicle at low cost but without really taking care to the quality of the food On the other side, in the modern distribution channel, which often sell products at higher price with more standard of products This is the reason why, the author assume the traditional market is market low quality compare to modern distribution channel From that point of view, the author set assumption and denotation Production function: a farmer is characterized by production function q  f     With λ is denoted for the labor used which transform in fruits and vegetables In this production function, the author set normalization rule with the wage w=1; in this model, N small farmers produce the same products (homogenous) for the middlemen which will finally sell in market low quality in the downstream of the food system Farmers produce products Q , the total supply of foods is denoted by Qm When selling products for middlemen, the farmer receives the price Pfm This price will be different and depend on downstream market power of middlemen The quantity which middlemen sell at final market denoted Q The author assumes that, middlemen will sell all quantity which he buys from farmers to consumer market It mean that, the quantity at final market must be equal to the supply of farmers or Q  Qm When selling at the final market, the price which middlemen receive is P The profit which farmers obtain when selling products for the middlemen is denoted  mf and the wealth of middlemen remained when sell products to the market denoted is denoted by  m The inverse supply function of farmers: The author assumes that, farmers play the game: with Pfm is the price paid by the middle man, he will maximize their profit to optimal level of labor used in the production A farmer obviously solves max  Pfm f      The optimal level of labor is therefore given  Pfm  by   Pfm     and the individual food supply is f  Pfm   Pfm   Therefore, the           total supply of foods S m Pfm for the middlemen is respectively given:  Pfm  Sm  Pfm   N     (1) And the inverse supply function of farmers  2Q  Pfm     N  (2) Middlemen, consumers and demand: the author introduces m middlemen indexed i They are symmetric and characterized by a linear cost function with simply is the transportation cost The cost function therefore is defined as following: C m  qm , i   C m qm ,i The author define the willingness to pay by the low quality index which denoted by ℓ Consumers at market low quality actually have two choices: they can buy low quality or not buy the products with the weight in the utility   0, K  Since K is the ranking of population who may enjoy buying in market low quality, the author set natural assuming that K  Cm This assumption implies that the willingness to pay must be large than the cost of the middlemen Since the consumers are uniformly distributed on [0, K], the demands D  p  for low quality food are respectively given by: 0ifP  K D  p    P   K    ifP  K   Since we have in hand D  p  , we can verify the inverse demand function, the inverse demand correspondence P : Q  R2 therefore is given by: P  Q     K  Q  ifQ  (3) Results 3.1 Downstream market equilibrium 3.1.1 Definition In many cases, the market power in the upstream may not attract middlemen For example, when many farmers supply their foods at the same time with big quantity, the price in the upstream is very low, or when index low quality in the downstream is high enough, middlemen interest on market power in the downstream of the food system Let us now study to the case of imperfect competition in the downstream in which middlemen has oligopoly market power In this case, he anticipates consumer demand and given the price    m *  to at market low quality P    q j  qi  At equilibrium, the definition of this case is given  ij1i    as: Definition 1.1: At market equilibrium of imperfect competition in the case of market power,  *j , q*j , p* , p *fm are defined as following:   Farmer maximize profit: max  Pfm f  j   j       m *   Middlemen maximize their profit: i , qi  max qi  P   q j  qi   Pfm  cm  qi   j 1      j i  *  m N i 1 m q*j   j 1 f   j  qi ; i 1 qi*  D  p*  Given by definition 1.1, the condition for optimization of middlemen is given as: i ,    qi     K  Q   Pfm  cm   By summing over i, equation becomes: i ,   Q     K  Q   Pfm  cm   m We therefore obtain the result: Q  m  K  Pfm  cm  (4)   m  1 Given by the definition of this case, we have considered that from the farmer optimal problem, at equilibrium, the supply of the farmer at (1) must be equal to the aggregate quality in the downstream, in other words, we have  m i 1 q*j  S  Pfm  , and we now use quantity to clear the market: m  K  Pfm  c   m  1   NP fm The price which farmer receiving from middlemen therefore is given as: Pfm   K  cm  N  N    m (5) To clear the market at the downstream, we replace Pfm at (5) to Q at (4), the trade quantity is given by: Q  K  cm 1      1 N m  Since we have in hand the trade quantity at market equilibrium, we can now compute the price at the final market low quality by using inverse demand function: P  Q     K  Q  at (3) The price at demand market P therefore given as: P  K  2m  N    mN c m  N   2  N  We can now move to verify the profit of middlemen in this case, which is given as following:  mDownstream   P  Pfm  c  QDownsrteam   K  cm   0  N m   2m  N   Nm    (6) Result 3.1: Given by the computation, we obtain the result of the case of imperfect competition in the case of downstream: Pfm Pfm  P  K  N  c P    mf Q K  2m  N    mN c m  N   2  N  Q   Q  N  1   N      N m  K  c 3.2 Comparative analysis The case of downstream market power in the conventional food distribution linked to typically the case of Vietnam, in which, at the local town level, we can observe that there is the big number of famers who living around the town producing foods; and there is also many middlemen who buy this products from farmers In this situation, the middlemen have no oligopsony market power However, in the downstream, middlemen sell all products at their small shops (which we call mom - and - pop stores, frog market, street markets, in this situation, they have market opligopoly market power Since the middlemen have market power in the downstream of the food distribution system, the basic property can be predicted that the price at final consumer market must be higher than it in perfect competition, but the trade quantity will be decreased Therefore, the price given to the farmers will be lower Let us now back to the results of the model to study how the situation is implied in the model In order to comparative analysis, let us firstly look for the case of bench mark case of market competition If we keep the same computation as downstream market power, we obtain the result of perfect competition as following: Result 3.2: Given by computation, we obtain the result of the case perfect competition Case Perfec t Competition ℓ ℓ ) ℓ − 2(ℓ − ) ℓ(2 + ℓ +2 ℓ +2 ℓ+ ℓ( ) > Zer o (For more detail of Result 3.2, please refers to Thanh, 2018) We firstly look for the difference of the P between perfect competition and Downsream Downsream downstream case, by replace PDownsream , PPerfect , Pfm , and Pfm at Result 3.1 and Result 3.2 to (6), we observe that: PDownsream  PPerfect  N   K  cm   m  N   2  N   N   2 0 (7) Since K  cm , we can now obtain that: PDownsream  PPerfect And: PfmDownstream   K  cm   K  cm   PfmPerfect  N  N    N    m   This result obviously appears as what we predicted in the context of Vietnam when middlemen have market power in the downstream of the food system, the price given to consumer is higher while the price given to farmer is decreased compare to perfect competition 2  Q  N   If we have in mind that,   N     , to compare profit of the farmer in this  N  m f case with the case of perfect competition, we just need to compare the trade quantity between two cases Since we consider that   Q perfect  Q Downstream   K  cm     N  perfect This result implies that Q 2 1     1   , we therefore have: N N  m       K  cm  0                   N  m    Qdownstream , and we can conclude that farmer’s profit in imperfect competition on downstream is smaller than farmer’s profit in the case of perfect competition:  mfm downstream  N    mfm perfect   N  (8) This result implies that, the wealth of middlemen is positive in the case of downstream market power of imperfect competition Concerning the comparison of the profit of the case of downstream with those in perfect competition, we obtain the result at (6) and (8), which indicates that the profit of farmers in the case of downstream is smaller than in pure competition, and profit of middlemen is positive compare to zero at benchmark case They obtain this profit from their market power by capturing a part of surplus of consumers and gaining profit from farmers by lower price Proposition 3.1: In the case of downstream when middlemen have oligopoly market power: Even it is competitive at final consumer market, the price given to consumers is higher (i.e PDownstream  PPerfect ) Less quantity are traded (i.e QDownstream  QPerfect ), and as consequence, the price paid Downstream  PfmPerfect ) to farmers is lower (i.e Pfm Profit of farmers is decreased since middlemen pay lower (i.e  Downstream (N)   mPerfect (N) ) f Profit of middlemen is positive by capturing apart surplus from consumers and paying lower to the farmers (i.e  mDownstream  ) 3.3 Optimal Land policy for the intervention of downstream market power 3.3.1 Theoretical Model of Land reform We construct model of land reform in order to make small land exploited and labor force used more frequently and effectively for the expectation of reducing the production cost and improving productivity Based on such consideration, we directly introduce the parameter of land reform in the food production of the farmer as following: q  f      In which, λ is labor use to produce vegetables The optimal labor used of the famers in this context is given by:   p fm         The total supplies of foods Qm   for the middlemen are respectively given by: Qm    N  p fm And the inverse supply function is defined by: p fm    2Qm N Since nothing is changed in the demand at the downstream of the food system, we observe that what is only changed in the equation of maximization problem of middlemen is that  multiply by N By using the same computation as in result (3.1), we obtain the prices and quantities at market equilibrium in the case of downstream: Result 3.3: The final solution of market equilibrium in the case of downstream is given by: p fm   p    K  cm     NK  mN cm   2mK   1    N  m  1        N  m  1  2m 3.3.2 The effect of land reform Q   K  cm 1     1   m  N To observe the effect of land reform on the prices and the quantities, we compute the elasticity which reflects the reaction of the prices to the changes of α This elasticity Ep fm in fact is computed by Ep fm  dp fm   d  p fm   and Ep  dp   d    p   Proposition 3.2: Given by our computation, the effect of land reform on prices and quantities in the case of downstream is given as follow: Elasticity of p fm 1      N   m   0    N           m   Elasticity of  Quantity p 2 m N  K  cm   N  m  1  2m   N   K  mc   2mK  m 0 dQ d   0 Proof: See appendix The result at proposition 3.2 show that the consumers buy food at the cheaper price  Ep   on final demand market while farmers receive lower price paid from middlemen ( Ep fm  0) on the food market supply of the farmers This result implies that land reform benefits to the consumer but have negative effect on farmers However, this situation can be improved by the fact that farmers can sell more products by improving productivity  dQ     and lower production cost by using land more flexible Our   d  results make sense with the empirical studies of Nguyen, 2012), which state that land reform in Vietnam have positive effects on crop productivity of households and increase food production These results obviously appear in our model since land reform improves productivity and benefit to both farmers and consumers by selling more foods and buying cheaper price Proposition 3.3: The reaction of the price in food supply market of the farmers is given by while the reaction of price in demand side of consumers is given by EPDownstream  EPPerfect fm fm EPDownstream  EPerfect  Poof: See Appendix This result gives us opportunity to understand the distortion introduced by imperfect competition We can observe that, in the case of downstream market power, because of perfect competition and productivity shock in the upstream, the cost of middlemen is decreased They therefore can decrease the price more than the cost to attract consumers; in some sense they reduce their market power That is the reason why But they don’t increase the quantity traded as perfect competition or in EPDownstream  EPPerfect fm fm other words, they want to buy less from farmers compare to perfect competition That is the reason why, the price given to farmers is more reactive compare to perfect competition EPDownstream  EPPerfect fm fm 3.3.3 Optimal land reform policy In order to organize this discussion, we adopt second best approach The reader however notices that in the case of perfect competition, we characterize the first best From that point of view, we have difference cases to compute the surplus of consumers net of production cost We also ask some specific costs link to the implication of land reform, they are given by CL  V   1 Definition 3.1: The second best productivity shock  is given by: Q* q Q2 max      K  q dQ*  cm Q*   *  V   1 *    With  N The general condition for the maximization problem of  is therefore given by:  2Q*  dQ Q2 *  K  Q  c    V   1       m  N  d  N  (9) Proposition 3.4: Given by our computation, the first and the second order conditions for optimization problem of FOC  Q Downsrteam  2N SOC in the case of downstream is given as follow:      2 N   1  V   1     N  1  m   2m     2  QDownstream    1  m 2 A  2m  A  1    V     N 1  m   2m 2  2   Proof: See appendix Existence: It remains to verify that there exists a unique solution for  FOC in the downstream case of market competition By the second order condition SOC, we have in hand that the function is decreasing It remain that to verify some boundary condition which ensure that solution between 1,   Proposition 3.5: We show that, there exists a optimal of   , which is the best choice of policy in the case of downstream market competition Proof: See appendix Our result show that, there exists a optimal of   which is the best choice of land reform policy in the case of downstream market competition Conclusions The paper highlights the competitive relationship between middlemen with the farmers in the downstream of the conventional food distribution system Based on the context of Vietnam, we propose the industrial organization for developing countries Our model shows that, at equilibrium, the downstream market power of middlemen has an important effect on both farmers and consumers The result indicates that, since middlemen have market power, there is always a distortion with respect to perfect competition in the price paid to farmers and sold to consumers In fact, the price paid to farmers is lower, while the price sells at the final consumer market keeping higher comparing to perfect competition This is the reason why we can go to conclude that with their market power, middlemen capture some profit from farmers and also take a part the wealth of consumers in the traditional food distribution system In order to intervene to market imperfect competition, we propose model of land reform policy in downstream market by introducing productivity shock At equilibrium, we study the effect of land reform on the prices and quantities, at the same time, we recognize how the wealth of farmers and consumers changed in the case of downstream market competition We finally show that, there existence of the optimal the best choice of land reform policy for the case of downstream market power Appendix Proof of proposition 3.2:  Elasticity of Pfm Downtream ( ) Since Pfm   K  cm  , we obtain:   1    N  m  1       1 1    K  Cm  N 1   N    dPfm  m   P  m  fm 2 d    1   1      N     N            m  m      1   N     m  EPDownstream   Pfm  fm    N 1        m    Elasticity of P Since P      1     N            m 0  P 1     N       fm    m       NK  mN cm   2mK  N  m  1  2m , N   K  mCm   N  m  1  2m   N  m  1 dP  d    N  m  1  2m    P E N  m  1  N  K  mCm   N  m  1  2m   N  m  1  2m  Downstream Pfm 2 m2 N  K  Cm  dP    d   P    N  m  1  2m   N   K  mCm   2mK  Proof Proposition 3.3:  EPDownstream  EPPerfect fm fm 1      N 1  m    N  EPDownstream  EPPerfect   fm fm    N       N       m   2 N    EPDownstream  EPPerfect fm fm  N   2m   N   Nm   EPDownstream  EPPerfect     N 2  Downstream EPPerfect  E    P     K  N  C  N      m    K  Cm   Km  N  K  mCm  mK   with  0  2m  N   Nm   Km  NK   Nm Cm   EPPerfect  EPDownstream   Proposition 3.4  FOC: if we consider that in case of imperfect competition on demand side, the condition for maximization problem of middlemen given as:  Q     K  Q   Pfm  Cm   m   i ,   K  Q   Cm  Pfm  Q m 2Qm And we also consider: Pfm  N i ,  Les us substitute   K  Q   Cm  Pfm  2Qm  Q and Pfm  to (9); We m N obtain the result:  2Q*  dQ Q2 *    V   1     K  Q   cm    N  d  N  Q2   dQ   Q    2  V   1  m  d  N dQ 2mQ  to (10), we have: d    N 1  m   2m  Therefore, if we substitute: FOC   (10)  Q2  2mQ     V   1   N    N 1  m   2m   SOC: FOC can be wrriten as:  Q2  2mQ  1  V   1    N    N 1  m   2m      (11) A Let us set   2mQ A  1 >1, we now can compute the SOC in the case of    N 1  m   2m     downstream, which are equal to: ' '  Q2   Q2  '  Q   A  V   1     A  A    V  N   N   N  '  Q2  Let us verify    , we obtain that N   ' 2Q 2mQ dQ  N  2 NQ2 2Q   N 1  m   2m   2 NQ d  4N2 4N2 Q     N  2Q2 N 1  m    N  N 1  m   2m  (12) '   2mQ 4Nm Besides: A    1     N 1  m   2m      N 1  m   2m  ' ' 2Q N 1  m   Q2  4Nm ' 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