Thursday, April 29, 2010

The Changing Economics of the Alligator Market

The New York Times has a good article on some recent changes in the alligator market. The alligator market has three main players: alligator farmers who collect eggs, hatch and raise alligators; tanneries who cure the alligator skins; and high-end fashion firms - such as Gucci and Hermes, which make handbags and watch bands and sell these products to retailers such as Neimen Marcus.

In the past, US alligator farmers were paid well for the alligator skins they raised. Lately the prices alligator farmers get from raising alligators are dropping. Not only that, but the amount of alligator skins that are being purchased is also falling. So how can prices and quantities both fall at the same time? Well, there are two reasons.

One is that there is a decline in the demand for alligator skin products, shifting the demand curve to the left and thus shifting the demand curve for alligator skins to the left. If producers behavior is unchanged, then this will result in market prices and quantities to both decline. Yet, as the article linked above mentions, the decline in the demand for alligator skin products does not seem to be the whole reason.

Another reason - and possibly an even more important one - is the changes economics in the alligator industry. As the article mentions, Hermes has been consolidating alligator tanneries since the mid-1990's, resulting in one company buying around a third of all alligator skins to be tanned. As a market - as the market for alligator tanneries - moves away from being competitive to being less competitive, the profit maximizing result is for alligator tanneries to use their market power and purchase fewer alligators and simultaneously pay lower prices for alligator skins.

In Prin. of Microeconomics we look at the monopsony market (which alligator tanneriers are not monopsonists in the purest sense) and notice that as the input market moves from competitive to monopolistic on the demand side, that input prices fall and the amount demanded by the monopolist also declines. This is the exact same result that alligator farmers are seeing. Thus, even when demand rebounds for alligator skin products, if we still see significantly lower prices and declines in the demand for alligator skins, the change in the amount of competition among alligator tanneries would explain why both alligator skin prices and quantities are decreasing.

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