During the 1980’s, most of the world’s sypply of lysine was produced by a Japanese company named Ajinomoto. Lysine is an essential amino acid that is an important live-stock feed component – 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 htat doubled worldwide production capacity. Experts conjectured that Ajinomoto and ADM had similar cost structures and that the marginal cost of producing an distributing lysine was approximately $0.7 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 this chapter to provide a potential explanation for what happened in the lysine market.
Substantiate your answer with calculations whenever possible.
Basically, Ajinomoto was charging monopoly’s optimal price. Here, V means profit and MV indicates marginal profit, in the following calculations.
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
By putting into Inverse Demand
P= (208-Q)/80
P= (208-76)/80
P=1.65
In this situation, Monopoly is making a profit of
V=PQ-CQ
V*=1.65*76-0.7*76
V*=72.22
Price war is triggering the entry of ADM because the price of each firm is P=0.70 which is at its marginal cost. This situation is because of homogeneous product of lysine.
The quantity demanded at this price would be.
Q=208-80P
Q=208-80*0.70
Q=152
Now, it is clear that each firm would like to produce 76.
Q1=q2=76
Here is the issue that each firm will earn zero profit because the price of each firm is at marginal cost. Such as
V1=V2=0.70*76-0.70*76
V1=V2=0
Both firms were acting as monopoly as they started conspiring. It is the same problem as it was earlier in the market. After the entry of ADM, the total market out and price are the same as it is Q=76 and P=$1.65. Each firm produces 38 as there are only two firms in the market.
Q1=Q2=38
Profit of each firm is as follow.
V1=V2=1.65*38-0.70*38
V1=V2=36.1
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