Experimental markets were used to isolate the effects of market structure and contract design on market outcomes. Preliminary results suggest that market structure drives outcomes, and not necessarily contract design. Future research will replicate experiments and add dimensions of market information.Political Economy,

Anderson, John D.

Harri, Ardian

Hudson, Darren

Turner, Steven C.

English

Research Papers in Economics

THE IMPACTS OF MARKET STRUCTURE AND CONTRACTS ON 
AGRICULTURAL MARKETS 
 
Darren Hudson, John Anderson, Ardian Harri, and Steven Turner
∗ 
 
Abstract 
Experimental markets were used to isolate the effects of market structure and 
contract design on market outcomes.  Preliminary results suggest that market structure 
drives outcomes, and not necessarily contract design.  Future research will replicate 
experiments and add dimensions of market information. 
 
Introduction 
  Agricultural markets have changed substantially in the last 30 years.  This 
evolution involves both market structure changes (numbers of buyers and sellers and 
relative market power) as well as innovations in business relationships (vertical 
coordination through alliances, joint ventures, and contracts).  Increased buyer 
concentration has led some to speculate adverse impacts on producer prices have 
resulted.  Others have argued that contract terms have placed producers at a price 
disadvantage as well (Xia and Sexton).  Of course, absolute price level changes resulting 
from these changes are difficult to discern due the underlying changes in supply and 
demand that drive price levels in secondary data.   
  Policy-makers and market participants would benefit from a better understanding 
of the impacts of changes in agricultural markets to develop more effective policies and 
business strategies.  However, most work on this subject to this point has been either 
                                                 
∗ Authors are Professor, Associate Extension Professor, Assistant Professor, and Professor and Head, 
Department of Agricultural Economics, Mississippi State University.  2007 by Hudson, Anderson, Harri, 
and Turner.  Readers may make verbatim copies for non-commercial purposes.  This paper was prepared 
for the 2007 Southern Agricultural Economics Association Annual Meetings.  This work is preliminary. completely theoretical or relies on secondary data that present many challenges to direct 
hypothesis testing.  The objectives of this paper are: (1) to examine the impact of 
alternative market structures on market performance and (2) establish a base on which to 
examine the impacts of alternative contract formulations and characteristics on market 
performance. 
 
Methods 
  Experimental markets are used to examine the impacts of alternative market 
structures and contracts on market performance.  Experimental methods have the 
advantage of being controlled, with the experimenter controlling the economic stimuli, 
allowing for direct tests of hypotheses (Smith; Hudson).  For example, one can control 
the supply and demand schedules of buyers and sellers, and then alter the number of 
buyers and sellers for a direct test of the impact of market structure. 
  We use a double-oral auction format in this experiment.  This format has the 
advantages that it is a well-established method for simulating markets, it is easy to 
modify while keeping other variables (supply and demand) constant, and is easy to 
implement so as to minimize respondent error.  Of course, the experiment loses some of 
the realism of a complex, functioning market.  But, the benefits of control far outweigh 
the costs of realism loss. 
  The double oral auction proceeds as follows: 
Step 1. Participants are randomly assigned as either buyers or sellers.  Buyers are 
presented with a “demand schedule,” which reveals their resale values as shown in Figure 
1.  One-half of the buyers receive schedule A and one-half receive schedule B.  These schedules represent the resale value for units purchased.  For example, for the first unit 
under schedule A, the participant could purchase that unit and resell it to the monitor for 
$0.72.  Thus, the buyer could purchase the unit from a seller for up to $0.72 and make a 
profit. 
  At the same time, sellers are presented with their marginal costs for each unit 
(again, one-half receive A and one-half receive B).  This value represents the amount of 
money the seller must pay the monitor to sell a particular unit.  For example, the first unit 
under schedule A is $0.48.  Thus, the seller could sell that unit for as little as $0.48 and 
still make a profit.  This process was explained to both buyers and sellers using 
hypothetical values.  The object, of course, is to trade units to maximize profits.  The 
equilibrium price and quantity predicted by these supply and demand schedules are 
shown in Figure 2. 
Step 2.  The trading session begins with the monitor calling the session open.  
Participants wishing to make a bid or offer are recognized and their bid or offer taken.  
Sequential bid improvement is followed such that each subsequent bid must be higher 
than the previous bid and each subsequent offer must be lower than the previous.  Once a 
bid/offer is accepted, the buyer/seller are recorded along with the transaction price, and 
trading begins again.  Each transaction is for one unit at a time, but each buyer/seller may 
purchase/sell as many units as desired during the trading round, which lasts five minutes. 
Step 3.  At the end of the round, buyers and sellers are provided with a new 
supply/demand schedule, which are just shuffled A/B schedules across rounds.  Then, 
Step 2 begins again.  There were 5 trading rounds used in this experiment.   Students were recruited from the undergraduate and graduate populations using 
standard recruiting techniques and were compensated $5 for their participation.  The 
experiment took approximately 30 minutes to complete and all respondents were paid in 
cash for their accumulated profits plus the participation fee.  Once recruited, students 
were randomly assigned to one of three treatments as described below. 
Treatment 1-Competitive Baseline 
  The double-oral auction experiment has been used for some time to simulate 
competitive markets (Smith; Davis and Holt), and comformity of results from this 
experiment with competitive market predictions is well established.  We use it here to 
establish a competitive baseline with which to compare other treatment outcomes. 
Treatment 2-Duopsony 
  A duopsony market was created in the double-auction format.  For this treatment, 
the original six buyers were aggregated into two buyers by horizontally summing the 
demand functions for three buyers into one.  This process results in an identical market 
demand function as in the competitive baseline, just with two instead of six buyers.  We 
maintained six sellers in the market to simulate the situation in agricultural markets 
where there were a larger number of sellers than buyers.  We make no generalization here 
that the ratio of buyers to sellers is representative of any particular market.  Rather, our 
goal was to alter the market structure in the experiment in favor of concentration of 
buyers to determine whether this change had a significant impact on market prices. 
Treatment 3-Contract Market 
  Contracts within markets have been hypothesized to have significant impacts on 
market outcomes.  A popular contract within cattle markets has been the top-of-the-market (TOMP) contract (Xia and Sexton).  In a TOMP contract, the buyer contracts a 
quantity of product from the seller for future delivery, but not the price.  The contract 
price is determined by the highest cash/futures market price at some point in time in the 
future.  To simulate this, treatment three was conducted in a number of steps outlined 
below. 
Step1.  Buyers and sellers privately determined the number of units they would 
purchase/sell during the trading period.  This information was marked on their recording 
sheet. 
Step 2. Buyers were given three minutes to make private contracts with sellers for a fixed 
quantity. 
Step 3. A double-oral auction market (five minutes) was then held for any uncontracted 
units remaining.  If there were no uncontracted units, the market price was determined by 
a random number generator using a uniform distribution of prices between $0.01 and 
$1.00. 
Step 4.  Return to Step 1 and repeat for five rounds. 
  To be consistent with treatment two, two buyers and six sellers were used.  There 
are two critical variables changing in this treatment.
1  First, respondents must make a 
capacity choice.  In this case, units that were produced/planned purchased in the capacity 
choice step that were subsequently not sold/purchased in either the contract or auction 
steps were penalized.  Units that were committed to be purchased by buyers but were not 
purchased were penalized an amount equal to the marginal value of unpurchased units.  
Units that were committed to be produced but were not sold were penalized an amount 
                                                 
1 We fully understand that to clearly test hypotheses that we need to change one variable at a time.  But, 
this paper is a report on preliminary work and subsequent treatments will be used to isolate all key 
variables. equal to the marginal cost of unsold units.  Secondly, this treatment only sold 
uncontracted units in the auction market, the highest price observed of which determined 
the market price for that round. 
  Based on theoretical predictions in the literature, one would hypothesize: 
3 2 1 P P P > > . 
That is, one would expect the price in the competitive market to be higher than under the 
duopsony market.  Also, given that only uncontracted units are being sold in the contract 
market, one would expect that the price in the duopsony market would be higher than in 
the duopsony with the TOMP contract.  In addition to market prices, we also examine the 
impacts of these market structures on distribution of revenues and profits across 
participants as well. 
 
Results 
  Figure 3 shows the results of treatment 1.  The horizontal line in the graph shows 
the predicted equilibrium price for a competitive market.  The vertical lines mark the 
ends of each trading round.  The average price across rounds was $0.598 and the average 
number of units traded in each round was 20.4, both of which conform to competitive 
market conditions.   
  Figure 4 shows the results of the duopsony treatment.  The average price in this 
treatment was $0.539 and the average number of units traded was 16.6, both of which 
were significantly different than the competitive baseline using an un-paired t-test.  Thus, 
as predicted by theory, the concentration of buyers did significantly lower the observed 
market price holding supply and demand conditions constant.   As would be expected given the price results, producer revenue was higher in the 
competitive case (Figure 5).  There was a more dramatic difference in profits between the 
competitive and duopsony structures (Figure 6).  This result, of course, is because not 
only did the producers receive a lower average price in the duopsony case, they also sold 
fewer units.  Thus, taken together, the results of these two treatments support the 
maintained hypotheses that concentration of buyers leads to lower average prices and 
lower average profits (surplus) to producers. 
  Figure 7 shows the resulting observed market prices from the secondary market in 
the TOMP treatment.  The horizontal line shows the average market price observed in the 
duopsony treatment above.  Here, the average price observed was $0.557, which is 
consistent with the average price in the duopsony treatment (not significantly different 
using an unpaired t-test).  However, the average number of units traded (contracted + 
secondary market) was 22.6, which was statistically greater than under the duopsony 
treatment.  Interestingly, however, the secondary market was only active for three rounds.  
This result appeared despite the fact that the participants faced a random price if no units 
were traded.  Interestingly, these findings do lend support to concerns about captive 
supplies, or conditions where all available supplies are contracted outside an open 
market.  But, further testing is needed before conclusions can be drawn. 
  We examined the income distributional impacts of these different market 
structures as well by calculating the percentage difference between the resulting 
allocation from the situation of perfect equity (as defined as an equal distribution of 
income across all producers).  As can be seen in Table 1, the competitive structure 
generates the most equal distribution of income (either revenue or profits) across producers.  The duopsony and TOMP markets generate comparable, but higher inequality 
as compared to the competitive case in terms of revenues.  But, these structures create 
substantially more inequality in terms of profits (surplus).  Thus, these results suggest 
that these structures are having important impacts on producer welfare as suggested by 
the literature. 
 
Conclusions 
  Our experimental results suggest that the decline in the number of agricultural 
buyers is having a significant impact on the revenues and profits of agricultural 
producers.  This research is still early in the process of development.  At this point, more 
replications of these treatments is needed to determine the robustness of the conclusions 
that can be offered. 
  At the same time, more treatments are need to examine key variables of interest.  
Planned treatments at this point include: 
1.  TOMP without penalties for overproduction/overcapacity, 
2.  TOMP with public disclosure of contracts, and 
3.  Fixed price contracts with/without public disclosure of terms. 
These additional treatments will allow the examination of the impacts of so-called 
“public disclosure” laws on market prices and producer incomes.  Additionally, more 
replications of each treatment will allow examination of other factors such as personal 
characteristics of market participants on market outcomes. References 
 
Davis, D., and C. Holt. Experimental Economics.  Princeton, NJ: Princeton University 
Press 1993. 
 
Hudson, D. “Problem Solving and Hypothesis Testing Using Economic Experiments.” 
Journal of Agricultural and Applied Economics, 35(2003): 337-347. 
 
Smith, V. “An Experimental Study of Competitive Market Behavior.” Journal of 
Political Economy 70(1962):111-137. 
 
Xia, T. and R. Sexton. “The Competitive Implications of Top-of-the-Market and Related 
Contract-Pricing Clauses.” American Journal of Agricultural Economics, 86(2004): 124-
138. Table 1.  Deviation from an Equal Allocation of Income Across All Producers in the 
Experiment. 
 Percentage  Deviation  from  Equal Allocation of Income 
 Competitive  Duopsony  TOMP 
Revenue  2.07% 2.68% 2.79% 
Profit  1.33% 3.38% 8.64%  
Figure 1.  Supply and Demand Schedules for Participants in the Double-Oral Auction 
Experiment. 
 
Supply and Demand Schedules
Unit Buyer A Buyer B Seller A Seller B
1 0.72 0.80 0.48 0.40
2 0.70 0.73 0.50 0.47
3 0.68 0.66 0.52 0.54
4 0.66 0.60 0.54 0.60
5 0.63 0.54 0.57 0.66
6 0.60 0.49 0.60 0.71
7 0.54 0.44 0.66 0.76
8 0.47 0.39 0.73 0.81
9 0.40 0.80
10 0.32 0.88
Marginal Revenues Marginal Costs 
 
Figure 2.  Predicted Equilibrium Price and Quantity from Supply and Demand Schedules 
Used in the Experiment. 
0
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Figure 3.  Resulting Transactions Prices of Double-Oral Auction Market Experiment 
Using Competitive Market Conditions. 
 
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Figure 4.  Resulting Transactions Prices of Double-Oral Auction Market Experiment 
Using Duopsony Market Conditions. 
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Figure 5.  Comparison of Producer Revenue in the Double-Oral Auction Experiment 
Between Competitive and Duopsony Market Structures. 
 
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Figure 6.  Comparison of Producer Profits in the Double-Oral Auction Experiment 
Between Competitive and Duopsony Market Structures. 
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Round 1 Round 2 Round 3 Round 4 Round 5
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Figure 7.  Observed Transactions Prices from the Double-Oral Auction Secondary 
Market in the Top-Of-The-Market (TOMP) Contract Treatment. 
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An Experimental

Experimental Economics.

Problem Solving and Hypothesis Testing Using Economic Experiments.”

The Competitive Implications of Top-of-the-Market and Related Contract-Pricing Clauses.”

The Impacts of Market Structure and Contracts on Agricultural Markets

The Impacts of Market Structure and Contracts on Agricultural Markets

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