By Alexander Apostolides on November 11, 2010

Economic theory suggests an investigation of the milk market



One of the most common complaints by students when teaching economics is the fact that the government has not done anything to reduce the price of milk in Cyprus. The government has first tried by suggesting an unwise maximum price and then has done nothing over the issue as it is unsure if the high price is due to illegal price fixing.

Yet economic theory suggests that the government should do more to pressure the milk firms. The milk market is an oligopoly market: there are very few firms and their revenues are directly influenced from each other. As a result firms in an oligopoly market are directly dependent to each other in terms in terms of their pricing policy and profitability.



Thus, oligopolistic firms, such as the milk companies, face a dilemma. They dislike competing on price: if they decide to reduce their own price, it might lead to the reduction of the competitor’s price, reducing the profit of all firms in the market. However in such markets there is keen non-price competition as firms they strive to convince the consumers that their product is better in order to make consumers loyal even if the competitor has a price advantage. A good example of a successful loyalty campaign is by coka-cola: how many people do you know that would not drink Pepsi if “Coke” was not available?

Oligopolistic firms in Cyprus do compete using non-price means through mass advertising and product differentiation. You can pretty much bet that 9 out of 10 advertisements on the TV are from firms in oligopoly markets, striving to convince consumers that their products are different and better: banks, diapers, sanitary pads, broadband services and supermarkets in Cyprus spend massively on advertising but are less keen to compete on price.

This is where the milk market is suspect. The non-price competition of the milk market has been lukewarm at best; when was the last time you remember a two for one special offer on milk? There is some advertising and some product differentiation for premium products, but its intensity is nothing like the other markets under oligopolistic competition in Cyprus. Thus an investigation by the government would be suggested by the theory as milk companies might be co-operating in illegally fixing prices as suggested by the relative paucity of their non-price competition.

Other factors also point out that the Cypriot milk market is a ripe contender for collusion. The limited number of companies makes secret price fixing negotiation easier. In addition unlike other oligopolistic markets, the milk market is quite isolated from non-Cypriot competition. Our lack of rapid direct access to other European markets means that the Cypriot companies are not facing the same level of competition than in other Cypriot markets by foreign companies: we buy Danish and Greek cheese as it does not spoil as easily as fresh milk, but it is difficult to see Cypriot consumers preferring Greek fresh milk as there would be valid doubts about its freshness.

The wise solution is not a maximum price of milk as this could lead to chronic shortages of such a basic commodity. The solution is the beginning of an formal investigation, in a national or EU level, with the promise of immunity from damages to any company that first provides evidence of a price fixing cartel. This will reduce the incentives of anyone in the cartel, and allow companies to damage the competition by admitting to price fixing. This common practise of the EU might provide the answer to whether there is collusion, of the market, and give the possibility to firms to clear their name and satisfy my students that the current price of milk is the lowest these companies can aspire.

3 comments:

  1. Dear Alex

    You have argued that there might be collusion (cartel) in the milk market. However establishing that a cartel exists both as a legal case and economically is not quite straightforward. The reason is that competition, for most of the times, is not one dimensional. For example in the milk market case the companies might compete with respect of prices, marketing/advertising expenses and/or compete on their suppliers (capture as more farmers as possible to increase their production) or even compete on a distribution level (which companies will manage to make a deal with a supermarket that will sell only their own product) and many more ways.

    So even if it seems that the price is high this might not be collusive since as you have correctly argued the market is isolated and oligopolistic and as a result of that the price will be higher from the competitive one. However empirically is almost impossible to distinguish whether a price observed in the market is competitive (in this case oligopolistic) or collusive (was set by a cartel). The main reason for that is the difficulty to estimate demand and companies cost function.

    Moreover advertising is not a very good tool because companies might argue that even though there is product differentiation in the market everyone (or almost everyone) produces exactly the same product which means that it is almost impossible to differentiate (between companies) even further. For example almost all companies offer low fat milk, however you will never see an advertisement of a company stating that its low fat milk is better. In addition researchers argue that advertisement has 3 main stages, informing the customer that the product exists, promoting the product and then reminding the consumer of the product. As a result of that companies might argue that there products are already established of the market and they don't really need advertisement to inform or promote their product.

    Now as for the motives that you suggest. You are totally right that providing immunity to the first company that admits the existence of a cartel is quite useful (note that this is already provided by anti-trust authorities). However this is problematic when the cartel is stable. In other words when the cartel believes that there is no way to be uncovered then no company will ask for immunity.

    To conclude I believe that it is not quite straightforward to prove that there is a cartel in the dairies market. However for a formal investigation to begin the anti-trust need no real proof to be realized (just the suspicion is enough and this holds by Law). In addition I do agree that a max price is not a wiser choice. What I propose is a closer monitoring of that industry by the anti-trust authorities and then if needed a formal investigation.

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  2. I totally agree that I have not proven a cartel. There are many factors involved, a lot of them can result in the result being abmigious:
    1) It might just be that the price of milk is high due to inefficient production of milk due to the lack of economies of scale since the size of the market is small. For this it might be nice to compare us with other small EU countries such as Malta.

    2) It might also be that the lack of a countervailing force of unified consortium of buyers of milk exists as in the UK. In the UK the near monospony of the large supermarkets as buyers of fresh milk has led to huge pressure to reduce prices and costs in the industry.

    3) it might just be due to environmental reasons. Like Saudi Arabian wheat, our geographical lattitute and dry climate might make milk production expensive

    Thus i Agree that it is not as simple and the market might just be operating under strenuous competition.


    All i want to point out that there are warning signs that make a study of the Cypriot Milk Market imperative. I am tired of grant statements by politicians that end up changing nothing. We all agree that the price of Milk is Cyprus is very high relative to other EU countries, but none of us seems to know why.

    So lets get the studies out and see how far do these potential issues explain the price; by removing issues we can reach to the fact weather or not this market is in a cartel situation.

    There are warning signs: Stable prices, a gradual reduction of advertising, and a lack of strenuous competition since some of the industries have mutual distribution firms.

    As for the issue of cartels, it is not my speciality, but our competition authority has been timid to say at best. If there is a cartel and it is stable, aggressive pressure by the regulator might just force a cartel might just force a potential cartel to fall apart.

    Always love your insights Joe.

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  3. Oh and i should say that i began writing a newspaper column where i try to explain economics simply. The target audience is people who have not studied economics.

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