SPATIAL PRICE DISCRIMINATION IN AGRICULTURAL

PRODUCT PROCUREMENT MARKETS: A

COMPUTATIONAL ECONOMICS APPROACH
MARTEN GRAUBNER, ALFONS BALMANN, AND RICHARD J. SEXTON
Signicant transport costs and spatially distributed supply and processing create oligopsony power in
agricultural markets. Price discrimination expressed in the form of partial or complete absorption of
freight charges by processors is often observed in these environments, but we understand little about
how these pricing decisions are made. Analytical approaches are often intractable. As an alternative,
we propose a computational economics approach to analyze a general spatial competition model and
study rms choices of spatial pricing policy. Instead of the commonly presumed free-on-board pricing,
we nd that buyers choose price discrimination, either through uniform delivered pricing or through
partial freight absorption.
Key words: agent-based model, duopsony, genetic algorithm, price discrimination, spatial price theory.
JEL codes: C63, C72, L13, Q11.
The farmer is the only man in our economy
who buys everything at retail, sells everything at
wholesale, and pays the freight both ways.
John F. Kennedy
Agricultural production is typically dis-
tributed over geographical space, and often a
large number of producers sell to relatively
few processors who are also distributed within
the producing region due to the expense of
shipping the product long distances. Shipping
costs limit a producers choice among buy-
ers because farm products are typically bulky
and/or perishable, and transporting them to
processing facilities is costly relative to the
product value (Fackler and Goodwin 2001;
Rogers and Sexton 1994). As a result, pro-
cessors consider only neighboring rms as
direct competitors, which creates oligopsony
Marten Graubner is a postdoctoral research associate at the
Leibniz-Institute ofAgricultural Development inCentral andEast-
ern Europe (IAMO), Halle (Saale), Germany. Alfons Balmann is
director at IAMO and a professor at the Martin-Luther-University
Halle-Wittenberg. Richard J. Sexton is a professor in the Depart-
ment of Agricultural and Resource Economics, University of
CaliforniaDavis and a member of the Giannini Foundation of
Agricultural Economics.
The authors thank Jeff Dorfman, Pierre Mrel, Klaus Sal-
hofer, and two anonymous referees for valuable comments and
suggestions.
Financial support by the German Research Foundation (DFG,
Project Reference No. BA-1654/11-1 and BA-1654/12-1) is grate-
fully acknowledged.
conditions inagricultural product procurement
markets. Processors canexercisemarket power
over production located proximate to their
plants due to producers high costs of accessing
outside buyers.
While incorporating transport costs in agri-
cultural market models has a long history,
most literature has followed the approach
of spatial equilibrium modeling, where the
spatial dimension of markets is reduced to
discrete points of supply and demand sepa-
rated by geographic distance (Takayama and
Judge 1964a,b). Such models are not use-
ful for analyzing procurement markets with
spatially dispersed production and process-
ing locations. Among models that do account
explicitly for the spatial dispersion of produc-
ers and processors, many assume perfect com-
petition, which ignores the market power that
is endemic to such settings (Bressler and King
1970; Dahlgran and Blank 1992; Mwanaumo,
Masters, and Preckel 1997).
One important consequence of spatial mar-
ket power is that it facilitates spatial price
discrimination, which occurs when the differ-
ence in net price offered by a processor at
two locations does not equal the difference in
transport costs due to serving those locations
(Phlips 1983). Threepricingregimes areusually
considered in spatial price theory (Beckmann
1976): free-on-board (FOB), uniformdelivered
Amer. J. Agr. Econ. 93(4): 949967; doi: 10.1093/ajae/aar035
Received September 2010; accepted April 2011; published online July 17, 2011
The Author (2011). Published by Oxford University Press on behalf of the Agricultural and Applied Economics
Association. All rights reserved. For permissions, please e-mail: journals.permissions@oup.com
950 July 2011 Amer. J. Agr. Econ.
(UD), and optimal discriminatory (OD). In a
procurement context, FOBpricing, also known
as mill pricing, involves a constant offer price
at the processing plant gate, with farmers being
responsible for costs of transporting the prod-
uct to the processor. Local prices thus differ
exactly by the transport cost differences among
locations. Producers receive the same price
irrespective of their location relative to the
processor under UD pricing, with processors
bearing nominally the entire transportation
costs. UD pricing represents an extreme form
of price discrimination against nearby produc-
tion. OD pricing is characterized by processor
prot maximization at each market point and
usually involves partial freight cost absorption.
Despite the prevalence of spatial price dis-
crimination in the real world (Greenhut 1981),
classic and contemporary texts on agricul-
tural markets focus exclusively on FOB pric-
ing (Bressler and King 1970; Hudson 2007;
Tomek and Robinson 2003). UD pricing has
been studied for only a few cases, including
California processing of tomatoes (Durham,
Sexton, and Song 1996), Spanish (Alvarez et al.
2000) and German (Graubner et al. 2011) raw
milk markets, and corn-based ethanol produc-
tion (Gallagher,Wisner, and Brubacker 2005.)
1
Partial freight absorption, when local price dif-
ferences reect only a certain share of the
transport costs, might be presentfor example,
when a processor deducts a hauling charge or
provides a hauling allowance. However, such
policies have received almost no attention in
an agricultural market context.
2
Therefore, a central question that this article
seeks to answer is: What determines the spatial
price policy of purchasers of agricultural prod-
ucts?The question has been studied on the sell-
ing side mostly for the case of spatial monopoly,
but the oligopoly case and procurement mar-
kets (either monopsony or oligopsony) have
received little attention. The few investiga-
tions that address the question for oligopoly or
oligopsony focus primarily upon the two polar
cases of FOB and UD pricing, even though
we know that OD pricing in general yields
superior prots in the monopoly/monopsony
case (Beckmann 1976; Beckmann and Thisse
1986; Lfgren 1986). The key reason for the
1
Durham, Sexton, and Song (1996) offer further examples of
UD pricing in agricultural product markets.
2
Notable exceptions are Bailey, Brorsen, and Thomson (1995),
who used a statistical model to detect partial freight absorption for
feeder cattle in the United States, and Lfgren (1985), who studied
the Swedish pulpwood market.
limitedtreatment is that the more general cases
of price discrimination and freight absorption
have proven to be intractable analytically.
We set fortha general theoretical framework
to study spatial pricing in agricultural mar-
kets. To account for partial freight absorption
we introduce a linear pricedistance function,
enabling processors to absorb any fraction of
freight charges in the interval (0,1), as well
as to choose the boundary cases of FOB or
UD pricing. We surmount the problem of ana-
lytical intractability of this general framework
by obtaining results based on a computational
economics approach. An agent-based model is
used to simulate the price-policy game in the
framework of a static noncooperative duop-
sony market.
Consistent with most prior literature, we
study a linear market, with farmers distributed
uniformly in the market space and a proces-
sor located at either endpoint. The results show
that the price strategy of the processor depends
on the importance of transportation costs rel-
ative to the net value of the nished product.
This measure of relative transportation costs
in turn determines the spatial differentiation
between rms and the intensity of their com-
petition to procure the farm product. Under
price (Bertrand) competition when space does
not matter, the equilibrium involves perfect
competition, as is well known. However, with
increasing importance of space, competition
decreases as the processors become differenti-
ated fromthe perspective of producers, and for
sufciently high values of transportation costs,
processors desired market areas do not over-
lap and each can act as a spatial monopsonist.
The simulations reveal that extreme price
discrimination in the form of UD pricing
emerges when the spatial dimension of the
market is less important and competition is
intense. Partial freight absorption (moderate
spatial price discrimination) emerges when
competition is less intense. In this case, the
degree of price discrimination decreases with
increasing relative transportation costs, con-
verging eventually to the OD pricing strat-
egy of a monopsony processor. Conversely,
despite its frequent use in agricultural mar-
ket models, FOB pricing does not emerge as
equilibrium behavior in the simulations. We
argue that these results are consistent with
what is observed in a wide range of agricultural
markets.
Subsequently, we briey present relevant
literature on spatial pricing and competition
before developing our theoretical framework
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 951
and deriving conditions regarding prot
maximization and market radii, which are
required to interpret the results obtained from
the simulations. The agent-based simulation
model is then illustrated through replicating
an analytical result for FOB pricing due to
Zhang and Sexton (2001). The model is then
extended to study pricing strategies based
upon the exible linear pricedistance func-
tion. Results for rms optimal spatial pricing
policies over the relevant range of transport
costs are presented, discussed, and related to
pricing policies observed in the real world.
Relevant Literature
Spatial pricing has been investigated most
often for the case of monopoly (Beckmann
1976; Beckmann and Thisse 1986; Greenhut,
Norman, and Hung 1987; Smithies 1941).
Smithies investigated the monopolists price
policy under a framework of linear price
distance functions. It is convenient to present
this formulation adapted to an input market
framework. We dene
(1) w(r) =mr
where the local (farm gate) price, w(r), is a lin-
ear function of the distance r to the processor,
a constant mill price m at r =0, and a uniform
portion [0, 1] of the freight costs .
3
We
denote the pair (m, ) as the processors spatial
price strategy. The degree of spatial price dis-
crimination is (1 ), which would represent
the hauling allowance per unit distance paid
by the buyer. Any <1 represents spatial price
discrimination because local price differences
do not fully reect the differences in transport
costs (Phlips 1983).
Depending on the shape of demand func-
tions, Smithies (1941) concluded that the spa-
tial monopolist would either use FOB pricing
( =1) or partially absorb freight costs but
never totheextent of UDpricing( =0). How-
ever, if FOBor UDpricing are the only options,
the rm is indifferent between them under
linear consumer demandandprefers FOBpric-
ing under concave demand and UD pricing
otherwise.
4
3
The case of >1, known as phantom freight charges, is not
considered because such charges can be eliminated by arbitrage
among producers.
4
Similar results regarding the equivalency of FOBand UDpric-
ing in terms of prots, output, and average price per customer
Only a few studies have investigated a
rms price-policy decision under competition.
Norman (1981) analyzed linear pricedistance
functions under two restrictive assumptions
regarding rms behavior under spatial com-
petition.
5
He showed that under certain con-
ditions, the degree of price discrimination
increases with increasing competition and can
yield UD pricing in the limit.
Most relevant for our study are papers by
Kats andThisse (1989; hereafter KT), Espinosa
(1992), and Zhang and Sexton (2001; here-
after ZS). In a noncooperative game and under
intense competition (i.e., when space is less
important), KT and Espinosa obtained a simi-
lar result to Norman (1981): high price discrim-
ination in the form of UD pricing emerges in
equilibrium. Espinosa also investigated linear
pricedistance functions and derived partial
freight absorption in equilibrium if competi-
tiveness of markets is intermediate.
6
However,
both KTand Espinosa (1992) assume perfectly
inelastic consumer demands subject to a reser-
vation price, and ZS show that their results
are biased in favor of UD pricing because this
strategy enables the rm to capture the entire
consumer surplus bysettingtheUDpriceequal
to the reservation price.
ZSs is the rst study of spatial price policy
under competitiontoconsider aninput market.
They investigate a two-stage, duopsony game
with FOB or UD pricing as the spatial price
option but assume linear farm supply func-
tions. Thus, in contrast to KT and Espinosa
(1992), agents located along the line are able
to alter their behavior in response to the local
price they pay or receive. In results that dif-
fer signicantly from prior studies, ZS nd that
FOB pricing is the dominant strategy if mar-
kets are highly competitive, mixed FOB-UD
pricing occurs for moderate competition, and
UDpricing is observedfor lowmarket compet-
itiveness. Fousekis (2011) adopts the ZS model
but makes one of the twoplayers a cooperative.
He nds that UD pricing emerges in equilib-
rium if markets are highly competitive, mixed
under linear demand functions and a xed market area have been
obtained by Beckmann (1976) and Beckmann and Thisse (1986),
as well as by Lfgren (1986) for the case of a spatial monopsony.
5
The competitionscenarios correspondtoparticular conjectural
variations regardingthereactionof onermtoapricechangebythe
other. Under one assumption, rms maximize their prots under
a given market radius, while under a second assumption, the local
price at the market boundary is assumed to be xed.
6
In Espinosas dynamic framework, competitiveness is mea-
sured in terms of the importance of space and the discount factor.
The most competitive market scenario is given if both values are
zero.
952 July 2011 Amer. J. Agr. Econ.
FOB-UD pricing emerges for intermediate
market structures (withco-ops using FOBpric-
ing), and FOB pricing results if the importance
of space in the market is sufciently high.
Thus, despite the pervasiveness of spatial
pricing in practice, there is much confusion in
the literature as to which policies emerge as
equilibrium strategies, with the extant litera-
ture limited in terms of the alternative strate-
gies it has considered and the ability of agents
to respond to price signals they receive. This
article extends the literature relative to ZS in
particular and other spatial competition mod-
els in general based upon our ability to handle
more complex and realistic market environ-
ments through use of the computational eco-
nomics framework. We reintroduce the linear
pricedistance function as a generalized spatial
price policy that nests FOB and UD pricing as
polar extreme cases. Accordingly, the proces-
sor simultaneously chooses two pricing instru-
ments: a constant mill price (m) and the degree
of spatial price discrimination (expressed in
terms of 0 1) to implement. We inves-
tigate this choice in a model of duopsony
competition and with elastic producer supply
response.
Spatial Price Theory
The basic structure of our model of a spatial
input market is standard (Alvarez et al. 2000;
Drivas and Giannakas 2008; Fousekis 2011;
Lfgren 1986; ZS) and represents adaptation
of the famous Hotelling (1929) duopoly model
to study input procurement. Two processors, A
andB, are locatedat the endpoints of a line with
length D. Producers of a homogeneous farm
product are distributed uniformly on the line
with unit density. A producers supply function
q(r) at distance r from a processors location is
assumed to be of the constant elasticity form:
q(r) =[w(r)]
e
, where e 0 is the price elasticity
of supply. The processors produce a nal good
g with technology g =min{q/v, f (Z)}, where
v =q/g denotes the xed conversion between
input and output, and Z is a vector of other
processing inputs. We set v =1 without loss
of generality and assume that other marginal
processing costs, c, are constant per unit of
output.
7
7
Under constant returns in the production technology of the
processors, xed costs provide a justication for limited entry
among processors and thus for spatial imperfect competition.
The processors receive a constant price for
the nished product, and the marginal value
product of the farm input is therefore =
c. This assumption of perfect competition
in the nal product market is also standard
(Lfgren 1986; Sexton 1990; ZS) and reects
that although farm product markets are local
or regional in geographic scope due to high
shipping costs, such costs for the nished prod-
uct are usually much lower, making the sales
market national or international in geographic
scope and, thus, subject to greater competition.
The importance of the spatial dimension of
a market and, hence, its competitiveness in the
Hotelling framework can be expressed as the
ratioof the unit transport rate times the market
length (D) to the marginal value product ( =
c) of the farminput: D/ (Hinloopen and
van Marrewijk 1999; Mrel and Sexton 2010;
ZS). Without loss of generality, we set D and
equal to one via normalizations. The normal-
ized transport rate t =/ thus measures the
real cost of transporting one unit of the input
per unit of distance, and the competitiveness
of the market is determined by t. For exam-
ple, low t implies that spatial differentiation
between rms is unimportant, and the procure-
ment market is highly competitive, while for
sufciently large values of t the rms desired
procurement markets do not overlap and they
operate as local monopsonies.
A processors prot per unit is the marginal
value product of the farm input net of its price
and transport costs. Multiplication by local
supply q(r) yields the prot at each location:
(2) =(1 w(r) tr)[w(r)]
e
.
A monopsonists prot-maximizing local price,
w

(r), can be determined by maximizing

equation (2) with respect to w(r) (Zhang 1997):
(3) w

(r) =
e(1 tr)
1 +e
.
Because w(r) =mtr and w(0) =m, the
optimal values for m and in the case of the
monopsony are:
(4) (m

) =

e
1 +e
,
e
1 +e

.
Because these costs do not inuence the models outcome, we do
not consider them further.
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 953
This OD pricing strategy involves freight
costs absorption by the processor because

=e/(e +1) <1. Moreover, the strategy is

independent of t and the size of the market
(Lfgren 1986). However, the market bound-
ary R, if not exogenously given(e.g., by aninter-
national border), is determined by at least one
of two conditions: (a) either the local price is
zero: mtR
1
=0 or (b) the processors local
prot per unit is zero: 1 m+tR
2
( 1) =0.
The effective border, R, is the lesser of these
two distances: R=min{R
1
, R
2
}, or stated more
formally:
(5) R=min

m
t

>0
,
1 m
(1 )t

0<1

.
The restrictions on in equation (5) apply
because =0 represents UD pricing, and then
there is no single location where local farm
price is zero, while =1 corresponds to FOB
pricing and then there is no single location
where local monopsony prot per unit is zero.
When given by equation (4), the processors
linear price strategy intersects the zero prot
line andthe zeroprice line at the same location.
Hence, the OD pricing strategy of equation
(4) maximizes R (Beckmann and Thisse 1986;
Lfgren 1986), and applying equation (4) to
equation (5) obtains R

=1/t. Using this rule,

we can calculate the upper limit of t that sepa-
rates spatial competition and (local) monop-
sony when processors desired market radii
do not overlap. This requires that R

=1/2.
Accordingly, processors A and B are local
monopsonists if t 2,
8
and therefore t [0, 2]
parameterizes theentirerangeof possiblecom-
petition outcomes, from perfect competition
(t =0) to pure monopsony (t 2).
Processors compete to procure supply for
all t <2, and results depend crucially on their
price strategies, which determine their market
areas and prots. A key analytical difculty
when considering possible asymmetric pricing
strategies between the rms, as well as strate-
gies involving freight absorption, is that a Nash
equilibriuminpurestrategies maynot exist due
to the potential for one rm to overbid its
rival and achieve a discontinuous expansion of
its market area and, hence, prots, withthe rival
facing a parallel discontinuous contraction.
8
Thus, given the normalizations, the market is a spatial monop-
sony if the distance separating processors multiplied by the unit
transportation costs is at least twice the net value of the nal
product.
The problem of nonexistence of
pure-strategy Nash equilibria created by
discontinuous payoff functions is explicated
for the general noncooperative-game case
by Dasgupta and Maskin (1986). It is well
known in the spatial literature for the case of
UD pricing (Beckmann 1973; KT; Schuler and
Hobbs 1982; ZS),
9
but the problem persists
also for a range of values of the linear price
schedule (m, ) and when rms can adopt
asymmetric pricing strategies. In essence, not
dissimilar to the UD pricing case (footnote 9)
the possibility exists to adjust (m, ) jointly
to overbid a rival over a discrete range of the
market space and thereby capture a discon-
tinuous increase in market share and prot,
making the payoff function discontinuous in
the strategic variables m and . Thus, extend-
ing processing rms choices of spatial pricing
policy to allow partial freight absorption and
selection of asymmetric pricing strategies,
although reective of choices rms can make
in the real world, presents intractable analyti-
cal difculties, making it impossible to obtain
a closed-form solution and motivating our
use of computational economics to simulate
noncooperative spatial competition under the
model framework described in this section.
Simulation
An appropriate simulation technique for spa-
tial competition must account for processor
and farmer heterogeneity based upon their
locations and possible differences in strate-
gic behavior. Processors interact strategically
as long as they are engaged in direct compe-
tition, i.e., t <2. Strategic interactions among
heterogeneous players can be studied with
agent-based modeling (ABM).
10
The purpose
of ABM is to investigate complex social sys-
tems through simulation (Axelrod 1997). In
our framework, an agent is either a proces-
sor or a farmer who is identied by a location
and a behavioral ruleprot maximization.
Farmers are assumed to act as price takers, but
processors exploit local market power.
9
The rm paying the higher price under UD pricing can acquire
product over the entire range of the market that it is willing to
serve at that price. Thus a small increase in price that enables a rm
to overbid its rival expands its market share and prot discontinu-
ously. An equilibrium exists in mixed strategies for the UD pricing
case (Beckmann 1973).
10
For an introduction and further information on ABM, see
Tesfatsion (2006).
954 July 2011 Amer. J. Agr. Econ.
A nite number of suppliers located uni-
formly along a linear market deliver product
to a processor (with one processor located at
each endpoint) who sets the higher price at
the producers location. Whena processor does
not offer service at the farmers location under
a pricing policy involving freight absorption,
farmers may deliver their product (at ship-
ping cost t) to the boundary of the processors
service area if it is protable to do so.
11
The objective of each processor is to max-
imize the sum of its local prots that are
denedfor eachlocationaccording toequation
(2). Whether a processor earns a prot at
location r depends on the local price w(r) =
max{w
A
(r), w
B
(1 r)} but also on the price
paid at other locations because of the possi-
bility of spatial arbitrage by producers (see
footnote 11). If the producer at location r has
offer w
A
(r), but no offer from rm B, the pro-
ducer may choose to deliver product to the
market boundary of processor B. Such arbi-
trage reduces the market area, supply, and
prot of rm A but has no effect on the prot
of rm B because its prot is zero for product
procured at its market boundary.
While the suppliers decisions are based
on the deterministic rule of price (prot)
maximization, processors have to identify
optimal strategies simultaneously. This prob-
lem exhibits nonconvexities, and conventional
Nash equilibrium search algorithms are likely
to miss the globally optimal strategy by fol-
lowing a local optimization path (Son and
Baldick 2004). Thus, we use a coevolutionary
genetic algorithm (GA), a method developed
to overcome this issue and identify the global
optima of the processors spatial decision-
making problem.
GAs represent a heuristic method for ran-
domsearchoptimization. Theyweredeveloped
by Holland (1975) and have been applied in
a broad range of disciplines (Foster 2001).
12
Important applications in economics include
the investigation of the repeated Prisoners
11
Any strategy involving freight absorption by the processor
must also involve setting a service-area boundary beyond which it
is not protable for the processor to procure product under that
strategye.g., see equation (5). We allow producers outside the
service area to ship product at their expense (shipping cost t) to
the boundary of the processors service area. Such producer arbi-
trage is discussed by ZS for UD pricing. The incentive also applies
under partial freight absorption when processors are unwilling to
serve the full market under their policy. The real-world analog to
such producer behavior is shipping product to receiving stations
operated by the buyer.
12
See Mitchell (1996), Goldberg (1989), and Dawid (1999) for
comprehensive discussions regarding the structure and function of
GAs with economic and general applications.
Dilemma by Axelrod (1984, 1997) and the
behavior of exchange rates by Arifovic (1996).
Price (1997) used a GA to model standard
games from industrial organization, including
monopoly as well as Cournot and Bertrand
competition, to demonstrate its relevance as
an analytical tool in such settings. Valle and
Ba sar (1999) andAlemdar and Sirakaya (2003)
modeled leaderfollower competition, while
BalmannandHappe(2001) exploredoligopoly
behavior in spatial agricultural land markets.
13
Ina simpliedway, the GAmimics biological
evolutionandis basedonsurvival-of-the-ttest
behavioral strategies (Dawid 1999). A GA
stochastically explores the solution space
for optimal (or close to optimal) strategies.
Depending on the application, the design of
GAs can vary greatly.
14
However, a GA basi-
cally consists of three components: a pool of
candidate solutions (a population), the objec-
tive (tness) function, and the genetic opera-
tors (selection, crossover, and mutation). We
rst describe briey the major features of the
GA and then illustrate its use in a particular
example.
The rst step of a GA simulation involves
random choice of z candidate solutions to a
problem. Usually, these candidate solutions are
not the decision variables themselves, i.e., the
phenotype. Instead, strategies are coded into,
for instance, binary strings of 0 and 1, i.e.,
the genotype. The genotype representation of
a candidate solution is known as a chromo-
some. Accordingly, suppose that x
A,i,k
(x
B,j,k
)
represents an encoded strategy of processor
A (B) with i, j ={1, 2, . . . , z} and k is a gen-
eration, which consists of tness evaluation
and the application of the genetic opera-
tors. Because of strategic interactions in our
model where the payoff (tness) of a strategy
depends on the strategy chosen by the com-
petitor, we use a coevolutionary GA (Price
1997; Son and Baldick 2004). The main char-
acteristic is that we initialize two populations
X
k
, one each for processors A and B such
that X
A,k
={x
A,1,k
, x
A,2,k
, . . . , x
A,z,k
} and X
B,k
=
{x
B,1,k
, x
B,2,k
, . . . , x
B,z,k
}.
Each of processor As strategies is then
played repeatedly against one of processor Bs
strategies selected randomly from X
B,k
and
13
The study by Zhang and Brorsen (2010) is a recent example of
anagent-basedapplicationto(nonspatial) oligopsony price compe-
tition in cattle procurement markets, where an alternative (particle
swarm optimization) algorithm is used to search for equilibrium
solutions.
14
See Graubner (2011) for a more detailed documentation of
the simulation model in this article.
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 955
vice versa. As a result, an average tness of
strategy x
A,i,k
can be determined subject to the
random vector x
B,k
of strategies drawn from
the competitors population (x
B,k
X
B,k
).
15
Based upon their tness values, good strate-
gies are selected for the next generation k +1.
We use a selection scheme where a predened
number z ( z z) of thettest chromosomes are
selected. To ensure the desired population size
z in each generation k, we ll up a new popula-
tion X
k+1
with z z random copies of already
selected strategies. These copies are selected in
proportion to the average tnessthe higher
the tness of a strategy, the more likely it will
be duplicated.
Because selection reduces the variety of
strategies and strategies that are even close to
the optimum are unlikely to be initialized in
a population, we need operators to increase
the variety within the population in order to
nd new and potentially superior strategies.
This is done by mutation and crossover. Muta-
tion is a random manipulation of a strategy
(e.g., switching 0 to 1 in the binary represen-
tation of a strategy to create a new strategy),
while crossover recombines the information of
two parent chromosomes, which yields (with
high probability) two newcandidate strategies.
Over a (high) number of generations, i.e., the
succession of tness evaluations and the appli-
cation of genetic operators, the GA solution
converges toward a Nash equilibrium solution
(Riechmann 2001; Son and Baldick 2004).
We illustrate the procedure by attempting
to replicate the analytical FOB-pricing equi-
librium derived by ZS. For all simulations
presented in the article, we used a GA with
z =25 candidate solutions (chromosomes) in
each processors population, selected z =20
strategies from each population in k for k +1,
and ran the GAover k
max
=2, 500 generations.
To determine an average tness value of each
strategy, we tested it with ve random strate-
gies (20%) of the competitors population. The
mutation rate, or the probability of a random
changeof somepart of achromosome, was 0.04.
The crossover rate, or the probability of ran-
dom recombination of two chromosomes, was
0.10. Crossover and mutation rates are con-
stant over generations and we used one-point
crossover where a chromosome is parted into
two segments at most.
15
Hence, the tness evaluation consists of a tournament of
strategies between both players.
Optimal FOB Prices in Duopsony
If both processors choose FOB pricing, ZS
show that a pure-strategy Nash equilibrium
in prices exists. The theoretical framework is
unchanged except that we set =1 in equation
(1) to coincide with FOB pricing and e =1
local supply is linear in the local price, that is,
q(r) =w(r), the assumption invoked by ZS.
16
Accordingly, a producer is indifferent between
delivering to processor A or processor B if
m
A
tR=m
B
t(1 R), which yields:
(6) R
A
=
m
A
m
B
+t
2t
, R
B
=(1 R
A
).
Under FOB pricing, a producers net price and
hence supply depends on his location, r, but a
processors local prot per unit is constant over
her market area:
(7) (m
A
, 1, R
A
) =(1 m
A
)
R
A

0
(m
A
tr)dr.
Using equation (6) to substitute for R
A
in
equation (7) and maximizing this function with
respect to choice of m
A
obtains processor As
price reaction function m
A
=m
A
(m
B
, t). Like-
wise, the reaction function of processor B is
m
B
=m
B
(m
A
, t). The intersection of reaction
functions represents a unique and symmetric
Nash equilibrium with m
A
=m
B
=m

f
:
17
(8) m

f
=
1
4

2 3t +

4 +t(13t 4)

.
The equilibrium FOB price is a rather com-
plicated, nonmonotonic function of t; it is
decreasing for t t

, where t

=2(1 +3

3)/13,
and increasing for t >t

up to the monopsony
price m

f
=2/3, which applies for t 4/3.
18
ZS explain the nonmonotonicity of m

f
(t)
as the result of two offsetting factors, a
competition effect and an elasticity effect.
Spatial competition between processors
16
This specication lacks generality, but, as ZS note, relative
to the inelastic demand assumption invoked commonly in mod-
els of spatial oligopoly, it is a parsimonious way to introduce the
key feature of making local supply responsive to the local price
paid.
17
We use the subscripts f , u, and o to refer to FOB, UD, and OD
pricing.
18
Under the FOB pricing framework the limit for t separating
spatial competition and (local) monopsony is lower compared with
the general linear pricing framework discussed previously because
the market radius under OD pricing, 1/t, is larger than under FOB
pricing, 2/3t.
956 July 2011 Amer. J. Agr. Econ.
Figure 1. Composition of processor As set of strategies at initialization and after the rst
generation
decreases with t, which enables them to pay
lower mill pricesthe competition effect.
However, a monopsony processor operating
with a xed market radius pays an optimal mill
price that is an increasing function of t.
19
This
strategy limits the reduction in local supply
from increasing t (and decreasing local prices)
by partial absorption of this increase by the
processor (Mrel and Sexton 2010) and rep-
resents the elasticity effect. The competition
(elasticity) effect dominates if t t

(t >t

),
yielding the price schedule in equation (8).
In applying the GA to the FOB pricing
problem, we randomly select z =25 mill prices,
m
A,i,0
and m
B,j,0
, for processor A and processor
B, respectively, in the economically reason-
able range of m [0, 1]. We then x a level of
transportation cost, say t =0.5. According to
equation (8), the symmetric Nash equilibrium
mill price is m

f
(0.5) 0.698, and substitution
into equation (7) yields
A
(m

A
, m

B
, 0.5)
0.087. We can evaluate processor As prot
(tness) for each m
A,i,0
for a randomly selected
strategy m
B,j,0
. For instance, one such element
in the initial randomization for processor A is
m
A,i,0
=0.71, and
av
A,i,0
(0.71, m
B,j,0
, 0.5) repre-
sents the average prot of m
A,i,0
=0.71 found
by repeated evaluation of it against a ran-
dom vector of processor Bs strategies, m
B,k
.
To determine the tness of all strategies, we
19
Holding R exogenous and solving the rst-order condition of
equation (8), we get m
f
=(2 +Rt)/4 and m
f
/t >0.
undertake repeated testing of strategies in a
tournament, where, for instance, all of proces-
sor As strategies (chromosomes) are tested
at least ve times and in different combina-
tions with strategies randomly selected from
processor Bs population.
The next step is to select the best strategies
from the set of potential solutions for proces-
sor A and processor B according to
av
i
().
Hence, we select the z =20 ttest strategies
from the original set and copy them into a new
set. We add z z =5 copies of already selected
strategies, where the probability that a strat-
egy is duplicated is directly proportional to its
tness. As a result, we obtain a new composi-
tion (population) of strategies for each player;
that is, we expect to nd a different distribu-
tion of strategies in the new set of prices. For
instance, several copies of a price strategy with
a relatively high tness may be included in the
population. Figure 1 illustrates this point by
comparing processor As initial set of strategies
with the set of the next generation of the GA.
Note that some of the strategies are con-
tained more frequently than others because of
selection, but there are also new strategies due
to mutation and crossover applied after selec-
tion.
20
Both operators are required because
20
While mutation manipulates a chromosome at one single loca-
tion, e.g., switching 0 to 1 in the binary representation of a strategy,
crossover exchanges sequences of 0s and 1s between two parent
chromosomes (two potential FOB prices) to yield two offspring
(twonewFOBprices). Wecanalsoillustratecrossover withthegen-
eral linear price strategy dened in equation (1). Suppose (m
i
,
i
)
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 957
Figure 2. The analytical Nash equilibrium and the results of the simulation
repeated selection of good strategies eventu-
ally results in a set of identical strategies for
eachplayerthe price withthe highest average
prot of the initial set of strategies of proces-
sor A and processor B. Of course, most likely
this strategy is not even close to the optimal
solution. Hence, the selection of good strate-
gies allows us tograduallyclimbtheobjective
function such that the average tness of the
population approaches the value of the best
strategy. This value can be, but does not have
to be, close to a maximum. Hence, the random
change of strategies ensures that the algorithm
not only is able to get closer to any optima but
also does not get stuck at a local optimum.
In gure 2, the analytical Nash equilibrium
outcome, equation (8), is compared with the
results of the GA simulation over the relevant
range of t. For each t ={0, 0.05, 0.10, . . . , 1.30},
30 simulations were conducted. The points
depicted in the gure represent averages
over the last 5% of 2,500 GA genera-
tions for each of the 30 runs and for both
players. Hence, we have 7,500 observations
(2500 0.05 30 2) for each value of t.
Even though the Nash equilibrium prices vary
considerably and are nonmonotonic in t, the
GA simulation is able to closely approximate
the analytical solution. The correlation coef-
cient is R
2
0.999.
and (m
j
,
j
) are two strategies in the processors population. One
possible outcome of crossover is the exchange of the decision
variables, i.e., (m
i
,
j
) and (m
j
,
i
).
Of course, we do not need the GA when
we can obtain an analytical solution. How-
ever, the replicationof known, albeit nontrivial,
results illustrates application of the GA and
provides a certainvalidationof its performance
and precision. Unfortunately we cannot pro-
vide this type of evaluation for the cases when
the GA is needed, namely when no analytical
solution is available.
Simulation Results: The Processors Spatial
Price Strategies
We now present simulation results from relax-
ing the FOB pricing assumption ( =1) and
allow m and to each range in the inter-
val [0, 1]. We carried out simulations for
t ={0, 0.02, . . . , 2}, i.e., the entire competition
range for t in increments of 0.02. The base
value of local supply elasticity chosen for the
simulations is e =1 (unit elastic) to enable a
direct comparison with the analytical results
contained in ZS for the polar cases of UD
and FOB pricing. However, we also report
results for two cases of inelastic farm supply,
e =0.25 and e =0.75, given the importance of
the inelastic-supply case in many agricultural
markets.
21
21
For example, Gardner (1992, p. 63) cites inelastic supply of
agricultural products as one of four essential elements of agri-
cultural product markets that jointly cause the so-called farm
problem of low and unstable farm incomes.
958 July 2011 Amer. J. Agr. Econ.
Figure 3. The processors equilibrium price strategy parameters m and
Figure 4. Frequency (F in thousands) of the strategy variables (m, ) for selected values of t
Results for both price strategy parameters
m and for the base case are presented in
gures 3 and4. Figure 3 depicts the average val-
ues of the decision variables for both players
over the last 5% of 2,500 GA generations.
Figure 4 shows their distribution for selected
values of t. First, notice that the expected
results are obtained for the limit cases of per-
fect competition and spatial monopsony. In the
rst case t =0, and m= =1 represents the
zero prot Bertrand outcome. Price discrimi-
nation (1 ) in this case is the mean of a uni-
form distribution due to the simulations ran-
dominitialization because does not inuence
the local price if t =0 andthuschoiceof has
no role in the optimization. The other extreme
is local monopsony when t >2, in which case
both processors use OD pricing, which from
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 959
equation(4) is characterizedfor theunit-elastic
supply case by 50% absorption of freight costs,
(m

) =(0.5, 0.5).
The distributions of m and provided in
gure 4 are unimodal, indicating that the simu-
lation results do not support the existence of
asymmetric equilibria; that is, rms optimal
strategies are symmetric. This observation is
consistent with the analytical result of Mrel
and Sexton (2010) for consumer markets and
spatial duopoly, which shows that elastic con-
sumer demands (equivalent to the elastic farm
supplies in our case) yield a unique symmetric
equilibrium under FOB pricing, whereas equi-
libria with asymmetric strategies exist in the
traditional inelastic-demand case.
Two general types of spatial price policies
can be identied from the results. When space
is not too important, as in the cases of t =0.4
and t =0.8 in gure 4 or more generally for
0 <t 1.07 in gure 3, strategies correspond
to UDpricing because the values for are near
zero. However, if t is sufciently high, such as
the cases of t =1.2 and t =1.6 in gure 4, we
observe only partial absorption of freight costs
(instead of full absorption under UD pricing),
withtherateof absorptiondecreasingas afunc-
tion of t. From below, and m both approach
the OD amount of freight absorption and mill
price of 0.5. Importantly, we do not observe
FOB pricing in the simulation for any t. These
results are thus considerably different from
prior work in general and ZS in particular.
Results for m in the interval t (0, 1.07)
are consistent with expected price behavior
in that the mill price decreases as differ-
entiation between the rms increases. How-
ever, this relationship is reversed for t (
1.07, 2.0). Similar results (e.g., gure 2) have
been observed for the case of FOB pricing
(Capozza andVan Order 1978; Mrel and Sex-
ton 2010; Salop 1979; ZS) and are sometimes
called perverse price effects (Gronberg and
Meyer 1981). Our results establish that the pat-
tern persists as it pertains to munder the linear
pricedistance function studied here.
UD pricing, the outcome under relatively
intense spatial competition (t [0, 1.07]),
represents too much price discrimination rel-
ative to what maximizes buyer prots because
the optimal level of freight absorption is
o
=
1/2 for our base case of linear supply func-
tions. Due to decreasing competition as t
increases in the range (1.07, 2.0), the proces-
sors are able to increase prots by simultane-
ously increasing the mill price and decreasing
the amount of freight absorption, converging
to the monopsony OD pricing optimum, as
gure3illustrates. Thus, althoughthemill-price
portion of the linear pricing strategy (m, )
behaves in a qualitatively similar fashion as
a function of t to the FOB price function
(compare gures 2 and 3), the economic expla-
nations for the respective pricing behaviors are
somewhat different. Whereas the FOB price
pattern is determined by the relative strength
of the competition and elasticity effects, as
describedpreviously(ZS), thepathfor munder
the linear pricing schedule is also inuenced
by processors opportunity to converge upon
OD pricing as competitive pressures wane for
sufciently large t.
Comparative statics of local prices, w(r),
for a change in t differ across locations
within a processors market area; produc-
ers are thus impacted differentially from an
increase/decrease in differentiation between
rms and, hence, the intensity of their compe-
tition. Figure 5 illustrates net prices received at
the median location, w(R/2), and the market
border, w(R), and also the quantity-weighted
average price w, where
w=

1
2
0
(mtr)
2
dr

1
2
0
(mtr)dr
=
1
3

2mt +
4m
2
4mt

.
22
(9)
These net prices decrease in t for t (0, 1.07)
in a relationship determined fully by the pat-
tern for m(t) illustrated in gure 3. Because
processors utilize UD pricing in this range,
producers do not directly bear any of the
increase int. However, because the mill price m
increases in t for 1.07 <t 2, while the degree
of freight absorption decreases, increases in
t in this interval affect producers differently
based upon their location. Indeed, producers
located sufciently close to the processor ben-
et on net from higher transport costs because
the increase in m dominates the increase in
their shipping costs caused by higher t and
higher .
23
For more distant producers, net
farm price continues to decrease in t in the
interval 1.07 <t 2, but at a decreasing rate.
22
Because both processors use the same price policy in equilib-
rium, R=1/2.
23
A clear example is producers located immediately proximate
to a processing plant, for whom the local price is w(0) =m in
gure 3.
960 July 2011 Amer. J. Agr. Econ.
Figure 5. The average market price w, the local price of the median farmer w(R/2), and the
price at the market border w(R)
Figure 6. The processors equilibrium price strategy parameters mand for inelastic producer
supply
Notably, althoughthere are signicant distribu-
tional effects from a change in t in this interval
based upon producer location, the weighted
average price is nearly constant in t in this
interval.
Inelastic Farm Supply
Figure 6 summarizes the simulation results for
m and for two cases of inelastic farm supply:
e ={0.25, 0.75}. These results demonstrate the
relative robustness of results for the base case.
As in the base case, we observe the theoretical
expected outcomes of perfect competition and
OD pricing in the two limit cases of t =0 and
t 2. Note however per equation (4) that both
m
o
and
o
decline in the OD price strategy as
farm supply becomes more inelastic.
We also observe, consistent with the base
case, a high level of price discrimination (very
low values for ) that closely resembles UD
pricing occurring over a signicant range of t.
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 961
Also similar to the base case, as competition
wanes with sufciently large t, rms decrease
the rate of freight absorption, and the strategy
converges upon OD pricing. However, in an
interesting contrast tothe base case, the thresh-
old value for t when the rate of freight absorp-
tionbegins todiminishis larger thaninthe base
case. As discussed in detail below, rms deviate
fromODpricing because the benet frommar-
ket share gained from deviating toward UD
pricing more than compensates for the reduc-
tion in local prots from deviating from OD
pricing. However, when individual farm sup-
ply is more inelastic than the base case, farm
price is less under all pricing strategies for all
t >0. Thus, capturing additional market share
throughhighrates of freight absorptionconfers
a greater benet in terms of prot margin the
more inelastic is producer supply, thus delaying
the advent of the inevitable convergence of the
pricing strategy to OD pricing.
Discussion
Tointerpret theresults of thesimulations, recall
that OD pricing as expressed in equation (4) is
prot maximizing at each location. Any change
of price strategy by a processor involves two
effects, which we call market-share and price-
optimization effects. Any deviation from local
OD prices diminishes local prots. The sum
of local prot differences between OD pric-
ing and any alternative strategy within a given
market area constitutes the price-optimization
effect, and it is always negative. However, a
positive market-share effect exists if the devi-
ation yields additional prots from a higher
market share gained at the expense of the
competitor, that is, from capturing producer
locations by overbidding the competitor in
the region of the market border. We show
that a processor has incentive to deviate from
OD pricing in the direction of higher price
discrimination.
If both processor A and processor B use OD
pricing (m
o
,
o
) =(0.5, 0.5) in the base case,
and they share the market equally, R=1/2.
Each processors prot is:
(m, , R) =(0.5, 0.5, 0.5)
=

0.5
0
(0.5 0.5tr)
2
dr
=(1/96)[12 +t(t 6)]. (10)
Suppose processor B uses OD pricing and
0 <t 1/2. Processor A can then earn posi-
tive prots at processor Bs location (and all
other locations served by processor B) because
(1 t >1/2 =m
o
). Processor A can capture
the whole market by, for example, adopt-
ing UD pricing and setting m
u
=1/2 . This
strategy is protable because (0.5, 0, 1) >
(0.5, 0.5, 0.5), where
(m, , R) =(0.5, 0, 1)
=0.5

1
0
(0.5 tr)dr
=(1/4)(1 t). (11)
If 1/2 <t 1, processor A cannot capture the
whole market against an OD-pricing rival
because processor As zero prot line and
the competitors OD price function intersect
in the markets interior, setting 1 tR
A
=
0.5 0.5(1 R
A
)t, and solving for R
A
yields
a maximum market area for processor A of
R
A
=(1 +t)/3t <1. To capture this area, pro-
cessor A can set, for instance, a UD price
m
u,o
=(2 t)/3 that matches the competitors
OD price at R
A
.
24
This strategy yields prot
(12) ( m
u,o
, 0, R
A
) =
2 +3t t
3
54t
and it is easy to show that [(2 t)/3, 0, (1 +
t)/3t] >(0.5, 0.5, 0.5).
Figure 7 illustrates the deviation from OD
to UD pricing for t =3/4. The light-gray
shaded area (1/2 r R
A
) illustrates the posi-
tive market-share effect, while the dark-shaded
areas in0 r <r
1
andr
1
<r 1/2 illustrate the
negative price-optimization effect. For r <r
1
,
the UD price is too low and results in a subop-
timal quantity supplied from farmers located
in that range. For r
1
<r <0.5, the UD price is
too high relative to the OD optimum.
Although the areas in gure 7 illustrate the
changes in processor As prot from deviat-
ing unilaterally from OD pricing, they do not
depict the actual changes in prot because
quantities produced at each location are not
depicted on the graph. However, comparisons
of equations (10), (11) and (12) establish that
the positive market-share effect for a deviation
24
The subscripts of m
u,o
refer to a UD price set in response to
a competitors OD price. We later discuss a UD price m
u,f
set in
response to a competitors FOB price.
962 July 2011 Amer. J. Agr. Econ.
Figure 7. The market-share and price-optimization effects when processor A unilaterally
deviates from OD to UD pricing (t =3/4)
Note: The dark-shaded areas represent the negative price-optimization effect on processor As prots caused by processor A deviating from OD pricing to UD
pricing, and the light-shaded area represents the positive market-share effect on processor As prots caused by its deviation from OD to UD pricing.
from OD to UD pricing exceeds the nega-
tive price-optimization effect. OD pricing thus
is not an equilibrium strategy under moder-
ate to intense spatial competition dened by
t [0, 1] because it is vulnerable to an over-
bidding strategy involving more extreme price
discrimination.
Consider now why FOB pricing is not an
equilibrium strategy. Suppose t is low, so that
processor A and processor B are relatively
undifferentiated, competition is intense, and
both processors use FOB pricing. The equi-
librium price m

f
is given by equation (8), and
the market border is R=1/2. Processor A can
deviate from FOB to UD pricing and set the
UD price at m
u,f
=(2m

f
t)/2 so as to hold
constant the local price at the market bor-
der, w(R) =m

f
tR, in which case the location
of the border R=1/2 remains constant, and
there is no market-share effect. Figure 8 com-
pares the local price differences for UD and
FOB pricing with the optimal (OD) prices.
The dark-gray shaded area represents the local
price differences between UDand ODpricing,
and the light-gray shaded area is the differ-
ence between FOB and OD pricing. The area
between the OD and UD price lines for r
1

r 1/2 is not shaded because it is part of the

reduction in prot relative to OD pricing for
both UD and FOB pricing. Comparison of the
respective prots demonstrates formally that
such a deviation is protable for moderate t:
(13) ( m
u,f
, 0, 0.5) (m

f
, 1, 0.5)t 2/3.
However, m
u,f
is not the optimal reply to the
FOB-pricing processor. Instead, the reaction
functionof theUDpricingprocessor as derived
by ZS calls for setting a UD price that is higher
than m
u,f
. This optimal reply yields a lower
price-optimization effect than m
u,f
but has a
positive market-share effect that more than
compensates for it. In the framework of ZS,
the best reply of the FOB-pricing competitor
processor B to processor As UD price is to
raise the FOB price instead of deviating to
UD pricing as well. This, in turn, makes the
UD pricing policy of processor A less prof-
itable and ensures either symmetric FOB or
mixed UD-FOB pricing equilibria under mod-
erate to intense competition when processors
are limited to only those pricing options.
As gure 8 illustrates, the negative price-
optimization effect of FOB pricing is large
absolutely. The price-optimization effect is
even worse for processor B if it raises its FOB
price in response to UD pricing by proces-
sor A (as in the case of ZSs mixed pricing
equilibrium). A high FOB price is, nonethe-
less, an optimal reply to (re)gain market share
in response to a competitors deviation to UD
pricing if there is no alternative pricing strat-
egyavailable. Ingeneral, however, FOBpricing
features the lowest market-share effect rela-
tive to other linear price strategies because it
forces distant producers to bear full transport
costs andthus is a relatively ineffective strategy
to capture market share. In our model, there-
fore, FOB pricing is never the best reply to any
strategy.
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 963
Figure 8. The price-optimization effects of FOB and UD pricing (t =1/2)
Note: The light-shaded area represents the negative price-optimization effect on processor As prots from adopting the optimal FOB pricing strategy,
m

f
, instead of OD pricing, and the dark-shaded area represents the negative price-optimization effect on processor As prots from adopting the UD price,
m
u,f
, instead of utilizing OD pricing. Analytical comparison of the respective areas conrms that deviation from FOB pricing to UD pricing is protable
against processor Bs use of the FOB price m

f
.
To amplify upon this point, consider the
market border R between processor A and
processor B under a linear price policy. The
intersection of the rms pricedistance func-
tions m
A

A
tR=m
B

B
t(1 R) yields
R=(m
A
m
B
+
B
t)/t(
A
+
B
). The market
share for processor A decreases in
A
:
(14)
R

A
=
m
A
m
B
+
B
t
(
A
+
B
)
2
t
0
whenever m
A
m
B

B
t, which must hold
because m
B

B
t is processor Bs price at
the location of processor A. Conversely,
R/m
A
=1/t(
A
+
B
) >0; that is, market
share is increasing in the mill price. Because
is xed at 1 under FOB pricing, increasing
the mill price is the only tool available to
processor B to counter processor As UD
price strategy in our example (apart from
also deviating to UD pricing). Introducing an
intermediate degree of price discrimination by
reducing would allow processor B to achieve
both a higher market-share effect and a better
price-optimization effect, making such a strat-
egy protable compared with raising the FOB
mill price. But this possibility is not present
in ZS. Hence, FOB pricing emerges in equi-
librium due to the lack of alternative pricing
strategies.
Spatial Pricing in Practice
The simulation results revealed spatial price
discrimination as an optimal strategy when
spatially separated processors compete to
procure farm products. UD pricing is equi-
librium behavior under relatively mild differ-
entiation between rms, and hence intense
spatial competition (0 <t 1.07) and par-
tial but high freight absorption emerges under
less intense competition, (1.07 <t <2). Con-
versely FOB pricing does not emerge in equi-
librium. Rather, the emergence of FOB pric-
ing in agricultural product procurement mar-
kets would appear to depend crucially on
the condition that more than one buyer is
present at each location, in which case a price-
discriminating rm can be overbid for produc-
tion near the joint location by an FOB-pricing
rival. Indeed such a characterization of compe-
tition is implicit in the classic point-space trad-
ing model (e.g., Takayama and Judge 1964a)
that presumes its use. Examples include the
shipment of fresh produce to traditional ter-
minal markets (e.g., Sexton, Kling, and Car-
man 1991) or to one of several packing houses
located in close proximity to intensive growing
regions (e.g., Cho 2004).
Conversely, for farm products that go to
processing where efciency considerations dic-
tate spatially dispersed processing facilities
located throughout a growing region, we
believe observed pricing practices are broadly
consistent with the predictions of this model.
Dairy processing and meatpacking represent
prominent examples for most countries, as
do fruit and vegetable processing, with spe-
cic products differing across countries and
regions based upon growing conditions. Clear
cases of UD pricing are readily observed in
964 July 2011 Amer. J. Agr. Econ.
these settings, as noted at the beginning of
this paper (Alvarez et al. 2000; Durham, Sex-
ton, and Song 1996; Graubner et al. 2011)
and are broadly consistent with intense spatial
competitionnal products that are valuable
relative to shipping costs (i.e., have low t).
Milder forms of spatial price discrimina-
tion, which are predicted in our model to
emerge under less intense spatial competition,
are often less transparent. Although the mag-
nitude of hauling allowances for transportation
costs borne by producers can be observed, as
by Locke andTurner (1995) for U.S. sugarbeets
and by McCarter (2011) for U.S. potatoes,
25
the actual transportation costs are typically
unavailable to the market analyst. However, in
most cases shipment is arranged by the buyer,
making it a rather simple matter to impose a
hauling charge upon the seller but to set that
charge at less than the actual cost, that is, to
partially absorb the freight cost. Further, under
buyer-provided shipping and negotiated pric-
ing at each farm location, a price policy that
nominally appears to be UD can in reality
represent only partial (instead of full) freight
absorption if the buyer offers a lower mill price
for product involving longer-distance hauls.
Lfgren (1985) related spatial pricing to the
case of renewable natural resources and pro-
vided evidence of partial freight absorption
in the Swedish pulpwood market. The pricing
of sugarbeets in Germany is also illustrative.
Processors typically use UD pricing to pur-
chase sugarbeets up to the quantity limits set
by the EUquota system(formally the so called
A- and B-quotas). Sugar gained from exceed-
ing supply must be sold on the world market
at a lower price. In this case, the processor
charges a portion (e.g., 50%) of the transport
costs to the producer. Because both types of
sugarbeet have the same transport costs but
the quota sugar has a higher product value, the
market is more competitive (t is lower) rela-
tive to sugar sold at the world market price.
Our results are consistent with the observation
of UD pricing in the rst instance and partial
freight absorption in the latter.
Summary and Conclusions
Many markets for agricultural products t
the basic spatial markets paradigm of many
25
McCarter discusses a lawsuit challenging whether a hauling
allowance was part of the producers cropproceeds andthus subject
to the security interests of a lender (Washington Farm Service, Inc.,
v. Olsen, 90 P.3d 1053 (Wash. 2004)).
producers and few processors distributed
within a region, along with high transportation
costs relative to the marginal value product
of the farm product. These features facilitate
the exercise of local market power and price
discrimination as part of processors spatial
price strategy. Nonetheless economic models
of these markets usually assume nondiscrimi-
nating FOB pricing. Spatial price discrimina-
tion, if considered, is generally the extreme
form of UD pricing. Despite its comparative
ease of implementation, partial freight absorp-
tion is neglected, likely due to the analytical
intractability of studying it.
The goal of this article has been to derive
insights into spatial pricing in agricultural mar-
kets by analyzing the determinants of the spa-
tial price-policy decision with a exible linear
spatial pricing schedule. Although reective
of choices rms have in the real world,
this pricing policy causes the correspond-
ing noncooperative competition model to
become intractable analytically. We offered an
alternative approach based on computational
economics methods.
UDpricing emerges as the equilibriumstrat-
egy under intense to moderate spatial compe-
tition. When competition is less intense, partial
freight absorption emerges as an equilibrium
strategy, with the degree of freight absorp-
tion decreasing with the increasing impor-
tance of space and converging ultimately to
OD pricing as the market converges to local
monopsonies. Finding spatial price discrimina-
tion in all market settings where transporta-
tion costs matter constitutes a major differ-
ence between our results and those of pre-
vious studies. More extreme forms of price
discrimination than OD pricing reduce prof-
its relative to OD pricing through a negative
price-optimization effect but enable a buyer to
captureagreater market shareandhigher prof-
its by offering high prices in the region of the
market border.
We believe that the results presented here
help to explain pricing practices for raw agri-
cultural products used for processing when
processing facilities are dispersed through-
out the growing region. Although agricultural
economists often presume the use of FOBpric-
ing in these settings, this analysis has shown
that discriminatory pricing strategies emerge
as equilibrium behavior. Although we have
cited some limited empirical evidence of use of
full (UDpricing) and partial freight absorption
in these cases, empirical studies are needed to
document the prevalence of alternative spatial
pricing arrangements.
Graubner, Balmann, and Sexton Spatial Price Discrimination in Agricultural Markets 965
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