The Nitrogen Fertilizers Crisis — Market Structure and Competition

Case

Table 1: Employment and consumption data on fertilisers

	2015	2016	2017	2018	2019
Number of workers employed in US fertilizers industry	19 133	19 580	20 058	20 837	22 179
Fertilizers consumed in US (million tons)	22.46	23.14	23.44	21.68	22.40
Fertilizers consumed globally (million tons)	213.27	215.13	217.42	213.77	215.37

Sources: IBISWorld and ourworldindata.org

Extract 1: The US fertilizer production industry

Fertilizers are a critical input for crop production and represent a major variable cost for several US crops. Farmers represent the end users in the fertilizers’ supply chain, and the prices they pay depend on several factors including local demand, product type, retailer mark-ups and transportation costs. The US fertilizers sector has undergone substantial changes. Between the 1980s and mid-2000s, the combination of lower fertilizers demand and higher input costs caused the sector to contract from 59 to 22 production facilities. The assumption is that highly concentrated industries are synonymous with market power, which can be detrimental to society. Whether that happens in reality relies on many factors, one of which is the level of government regulation in the fertilizers market.

Source: Choices and the Agricultural & Applied Economics Association, 2020

Extract 2: USDA announces plan to support US farmers

The US Department of Agriculture (USDA) will support American farmers by increasing fertilizer production to address its rising costs. It is offering a $250 million new grant to encourage greater production of fertilizers. Additionally, to address growing competition concerns in the agricultural supply chain, USDA will launch a public inquiry into agricultural fertilizers and the impact of concentration and market power on farmers. “Concentrated market structures and potentially anti-competitive practices leave America’s farmers, businesses and consumers facing higher costs, fewer choices and less control about where to buy and sell, and reduced innovation,” said the Agriculture Secretary.

Source: US Department of Agriculture, 11 March 2022

Extract 3: Fertilizer costs: what is driving the increase?

A significant increase in the cost of fertilizers over the past year has caused concern among US farmers. The cost of fertilizers now accounts for approximately 15–20% of total costs for corn production. Farmers in some areas are reporting prices more than 300% higher than last winter. The price increase was driven by strong domestic and global demand for crops, low fertilizer inventories and very slow adjustments in production by the US fertilizers industry. As fertilizers are a global commodity, prices can be influenced by various factors beyond the control of US producers. Two-thirds of global fertilizers demand is driven primarily by the production of crops, of which corn, wheat and soybeans constitute about 36%. As a large producer of these crops, the US is a large consumer of fertilizers.

Trade disputes and disruptions have also played a role. The US has restricted imports of selected factor inputs such as potash from Belarus, which contributes about 20% of global potash production. Uncertainty over Russian actions against Ukraine creates further volatility, since Russia is one of the top exporters of all three fertilizer raw materials — nitrogen, phosphate and potash. Prices can also be influenced by internal factors such as increased domestic transport costs due to labour shortages in the freight industry, and domestic weather conditions such as hurricanes and ice storms causing production and distribution disruptions.

Source: Institute of Agriculture and Natural Resources, 8 February 2022

Questions

(a) With reference to Table 1, identify the difference in the trend of number of workers employed in the US fertilizers industry and the consumption of fertilizers in the US from 2016 to 2019. State one possible reason for the difference. (identify, [2])

(b)(i) With reference to Extract 1, explain how the lower demand for fertilizers and higher input costs could cause firms to exit the US fertilizers industry. (explain, [4])

(b)(ii) Explain how market dominance could lead to an inefficient allocation of resources in the US fertilizers market. (explain, [6])

(c) Discuss how improving the level of competition in the US market for fertilizers can affect dynamic efficiency. (discuss, [8])

(d) Discuss whether demand or supply factors have a greater impact on the price of fertilizers in the US. (discuss, [10])

[Total: 30]

Essay practice (b). Faced with a drastic drop in revenue due to COVID-19 safe-distancing measures, some food and beverage (F&B) owners have succumbed to the challenges. In an attempt to stay afloat, eateries have employed strategies such as food delivery and reducing staff. Discuss the strategies that firms may use to remain in business amidst the challenges brought about by COVID-19. (discuss, [15])

Answers

(a) — identify [2].

From 2016 to 2019 the number of workers employed showed an increasing trend, while consumption of fertilizers in the US generally decreased. A possible reason: although US domestic demand was falling, foreign demand may have risen, raising export revenue to US producers and so leading them to employ more factors of production, including workers. (Marks: one difference in trend [1]; one valid reason [1].)

(b)(i) — explain [4].

A fall in demand lowers the market price, so incumbent fertilizer firms earn a lower average revenue (AR). Higher input costs raise the firms’ cost of production and so their average cost (AC). By the shut-down conditions, a firm exits in the short run if average variable cost exceeds average revenue, and exits permanently in the long run if average cost exceeds average revenue. With AR falling and AC rising, both benchmarks are more likely to bind, so firms are more likely to shut down and exit the industry in both the short and long run. (Marks: impact on AR [1]; impact on AC [1]; shut-down conditions [2].)

(b)(ii) — explain [6].

This part is worked in prose; the original answer’s supporting figure is a firm-level cost/revenue (AR/MC/MR) diagram outside the 9570 diagram set (see scope note below).

Allocative efficiency is achieved when resources produce the combination of goods most wanted by society, which occurs where price equals marginal cost ($P = MC$) — the socially optimal output $Q_S$. Market dominance arises when a firm with price-setting ability sets price above the socially optimal level and so produces below the socially optimal output. A profit-maximising dominant firm produces where MC = MR, at an output $Q_M$ that is lower than $Q_S$, so resources are underallocated to the good. Society incurs a deadweight welfare loss from this underallocation, which is precisely an inefficient allocation of resources. (Marks: definition of allocative efficiency [1]; $P = MC$ / socially optimal output [1]; what market dominance is [1]; output at MC = MR below optimum [1]; underallocation [1]; deadweight welfare loss [1].)

(c) — discuss [8].

Thesis — competition improves dynamic efficiency. Improving competition by lowering barriers to entry raises the threat of entry. If new firms enter, incumbents’ profits are eroded, so profit-maximising incumbents engage in process and product innovation to stay competitive. Process innovation — for instance, streamlined procedures — lowers average cost; product innovation — new varieties — better matches consumer tastes, raising demand and average revenue. Higher AR and lower AC help firms defend their profit, and the industry becomes more dynamically efficient.

Anti-thesis — competition reduces dynamic efficiency. As competition rises, incumbents’ profits fall: with the market size fixed, each firm’s market share and so average revenue decline. Producing at a lower output, firms also reap fewer internal economies of scale, raising average cost. The resulting fall in supernormal profit leaves firms less able to fund the R&D that innovation requires, reducing dynamic efficiency.

Judgement. The effect depends on how competition is improved. If the government promotes competition through innovation grants that subsidise R&D, dynamic efficiency is likely to rise, since firms become more willing and able to innovate. If it relies on deregulation alone, incumbents may lose the profit that funds innovation and become less dynamically efficient. The policy instrument, not competition as such, is decisive.

(d) — discuss [10].

Supplied to complete this case study; see the ingestion note for csq_ms. The reasoning follows the demand–supply framework set out in the linked notes.

Stand: on the evidence, supply factors have the greater impact on the US price of fertilizers.

Demand factors raise price. Extract 3 notes “strong domestic and global demand for crops” and that two-thirds of fertilizer demand is derived from crop production. As a non-price determinant of demand — derived demand from crops — strengthens, the demand for fertilizers shifts right. At the original price this creates a shortage, exerting upward pressure on price until a new, higher equilibrium is reached.

Supply factors raise price. Extract 3 lists several supply shocks: import restrictions on potash from Belarus (20% of global supply), the threat to Russian exports of all three raw materials, higher domestic transport costs from freight labour shortages, and weather-driven production disruptions. Each raises the cost of production or restricts availability, shifting the supply of fertilizers left. With “very slow adjustments in production” — a price-inelastic supply — the leftward supply shift causes a more than proportionate rise in price.

Judgement. Supply factors dominate. Extract 3 reports prices “more than 300% higher than last winter” — a magnitude consistent with a sharp, inelastic supply contraction rather than gradual demand growth. The concentration of raw-material supply (Belarus, Russia) and the slow production response mean supply shocks pass through to price almost fully, whereas demand from crop production grows more steadily. (One caveat: because fertilizer demand is itself derived and price-inelastic — fertilizers are a necessity input with few substitutes — a demand surge can also move price sharply; but the evidence here weights the supply side more heavily.)

Essay practice (b) — discuss [15].

Definitions. A firm remains in business if it does not satisfy the shut-down conditions in the short or long run. Scope: strategies that raise revenue (such as product diversification) or cut cost (such as process innovation). Stand: under COVID-19, firms should focus on product diversification.

Precursor. A firm exits in the short run when average variable cost exceeds average revenue, and in the long run when average cost exceeds average revenue. During the pandemic, revenue falls under restrictions and weak consumer and investor confidence lowers demand, making firms more vulnerable to closure.

Requirement 1 — diversification raises AR. Product diversification lets a firm enter new markets and open new revenue sources. A wider product range appeals to more tastes and preferences, raising demand and so average revenue. During Singapore’s Circuit Breaker, F&B firms that added food-delivery options reached consumers who could not dine in, sustaining revenue. Evaluation: diversification is risky — new products may not appeal to consumers, so the revenue gain may be overstated.

Requirement 2 — process innovation lowers AC. Process innovation — investing in better capital or technology — raises factor productivity and lowers average cost. A coffee shop automating drink preparation, for instance, cuts labour cost. Evaluation: process innovation is costly, requiring R&D, and consumers may read automation as lower quality, depressing average revenue and offsetting the cost saving.

Judgement. Firms should favour product diversification over process innovation under COVID-19. With profits falling, most firms lack the budget for expensive process innovation and R&D; many Singapore firms are in monopolistically competitive industries earning only normal profit in the long run, so cannot fund it. Diversification can also be deployed with minimal time lag, raising revenue in the short run when restrictions arrive at short notice, whereas process innovation’s long R&D lead time makes it ill-suited to an immediate survival problem.

Note: in the original worksheet b(ii) and the essay-practice answer were supported by firm-level cost/revenue (AR/MR/AC/MC) diagrams with profit areas and the Qm–Qs gap. Those market-structure equilibrium diagrams are outside the 9570 syllabus and are presented as prose here. Part (d) had no answer in the source; a complete worked answer is supplied above, grounded in the demand–supply notes. The two demand–supply figures above are in-scope supply_demand archetypes.