During the 1980s, most of the world’s supply of lysine was produced by a Japanes

Question

During the 1980s, most of the world’s supply of lysine was produced by a Japanese company named Ajinomoto. Lysine is an essential amino acid that is an important livestock feed component. At this time, the United States imported most of the world’s supply of lysine—more than 30,000 tons—to use in livestock feed at a price of $1.65 per pound. The worldwide market for lysine, however, fundamentally changed in 1991 when U.S. based Archer Daniels Midland (ADM) began producing lysine—a move that doubled worldwide production capacity. Experts conjectured that Ajinomoto and ADM had similar cost structures and that the marginal cost of producing and distributing lysine was approximately $0.70 per pound. Despite ADM’s entry into the lysine market, suppose demand remained constant at Q = 208 – 80P (in millions of pounds). Shortly after ADM began producing lysine the worldwide price dropped to $0.70. By 1993, however, the price of lysine shot back up to $1.65. Use the theories discussed in the chapter to provide a potential explanation for what happened in the lysine market. Support your answer with appropriate calculations.

Explanation / Answer

Initially, Ajinomoto charged a monopoly's optimal price. I use V to mean profit and MV to mean marginal profit. V = PQ - CQ Q = 208 – 80P Inverse demand: P = (208 - Q)/80 CQ = 0.7*Q V = [(208 - Q)/80]*Q - 0.7*Q MV = 208/80 -Q/40 - 0.7 = 0 Q* = [(208/80) - 0.7]*40 Q* = 76 Plug this into inverse demand P = (208 - Q)/80 P = (208 - 76)/80 P = 1.65 The monopoly makes a profit of: V = PQ - CQ V* = 1.65*76 - 0.7*76 V* = 72.2 The entry of ADM triggered a price war (Bertrand competition) such that each firm priced at marginal cost. P= 0.70. This happened because lysine is a homogeneous product. The quantity demanded at this price is given by: Q = 208 – 80P Q = 208 – 80*0.7 Q = 152 Each firm would produce 76. q1=q2=76 But each firm earns zero profit because they each price at marginal cost. V1=V2=0.7*76-0.7*76 V1=V2 = 0 So, they started colluding and act as if they were a monopoly. This is the same problem as earlier. The total market output is Q=76 and P=1.65. But since there are two firms, each firm only produces 38 q1=q2=38 Each firm's profits is given by: V1 = V2 = 1.65*38 - 0.7*38 V1 = V2 = 36.1

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