Question

Food service firms buy meat, vegetables, and other foods and resell them to restaurants, schools, and hospitals. US Foods and Sysco are by far the largest firms in the industry. In 2015 , these firms were attempting to merge to form a single firm. A news story quoted one restaurant owner as saying, "There was definite panic in the restaurant industry \(\ldots\) when the merger was announced. They know they're going to get squeezed." a. Analyze the effect on the food service market of US Foods and Sysco combining. Draw a graph to illustrate your answer. For simplicity, assume that the market was perfectly competitive before the firms combined and would be a monopoly afterward. Be sure your graph shows changes in the equilibrium price, the equilibrium quantity, consumer surplus, producer surplus, and deadweight loss. b. Why would restaurant owners believe they would be "squeezed" by this development? c. Ultimately, the merger did not occur because the Federal Trade Commission was successful in suing to stop it. The judge who decided the case wrote, "The proposed merger of the country's first and second largest broadline foodservice distributors is likely to cause the type of industry concentration that Congress sought to curb at the outset before it harmed competition." Briefly explain what the judge meant by "industry concentration" and what the results will be of a merger that harms competition.

Short answer

A merger between US Foods and Sysco would create a monopoly, increasing the price and decreasing the quantity of goods in the market. The consumer surplus would decrease due to price increases and producer surplus would grow. This would squeeze restaurant owners who will have to pay more to get less. This form of industry concentration can lead to challenges like price manipulation and reduced service quality, which is likely why the FTC blocked the merger.

Step-by-step solution

Analysing the Market Combination

In a perfectly competitive market, several businesses sell identical products, leading to an equilibrium price and quantity based on the supply and demand. If US Foods and Sysco merge, they'll form a monopoly, significantly reducing competition. This change will affect the supply curve, decreasing the equilibrium quantity and increasing the equilibrium price.

Graphical Representation

To visually illustrate the changes, a graph should be plotted. In a perfectly competitive market, the supply and demand curves intersect at an equilibrium price and quantity. In a monopoly, the supply curve shifts left, leading to a rise in price (P2) and a decrease in quantity (Q2). The area beneath the demand curve and above the price level represents the consumer surplus which decreases due to the merger. Producer surplus, represented by the area beneath the price level and above the supply curve, increases due to higher prices. The deadweight loss, a measure of economic inefficiency, is the area between the demand and supply curves that isn't included in the consumer or producer surplus.

Impact on the Restaurant Owners

Restaurant owners believe that they would be 'squeezed' because of the monopoly created by the merger. If the two largest firms merge, they can dictate prices due to lack of competition, resulting in higher costs for the restaurant owners.

Explaining 'Industry Concentration'

Industry concentration refers to the extent of market share held by the largest firms in an industry. A merger of the two largest food service distributors would significantly concentrate the industry, affecting competition negatively. Competition ensures fair prices and innovation, while its absence can lead to price manipulation, reduced quantity and decreased customer service quality.

Key concepts

Perfect Competition

In a perfectly competitive market, numerous sellers offer identical products, and no single firm can influence the market price or quantity. Consumers benefit from the lowest possible prices due to the intense competition among sellers.

In such a market, all firms are price-takers, meaning they accept the market price as given. This scenario leads to an optimal allocation of resources, wherein goods are produced at the lowest cost and the quantity supplied meets the quantity demanded at the equilibrium point.

Monopoly

A monopoly is a market structure where a single firm dominates the market, either due to unique products, significant barriers to entry for other firms, or both. Unlike in perfect competition, a monopoly has substantial control over the price of its products as it is the sole supplier.

The monopolist will typically charge higher prices than in a competitive market because it can restrict output to maximize profits. This leads to a loss of consumer and producer surplus, as well as the creation of deadweight loss, which represents the loss of economic efficiency.

Consumer Surplus

Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. It's a measure of the economic benefit consumers receive when they purchase a product at a market price that is less than the highest price they're willing to pay.

In a perfectly competitive market, consumer surplus is high because the intense competition keeps prices low. However, in a monopoly, consumer surplus tends to be lower as the monopolist can set higher prices.

Producer Surplus

Producer surplus represents the difference between what producers are willing to accept for a good or service and the actual price they receive. It measures the benefit to producers from selling at a market price that is higher than the lowest price they are willing to accept.

In a monopoly, the producer surplus may increase because the monopolist can set a higher market price. However, this increase comes at the expense of consumer surplus and overall economic welfare.

Deadweight Loss

Deadweight loss is the loss of economic efficiency that occurs when the equilibrium for a good or service is not achieved. In the context of a monopoly, this happens because the firm produces less output and charges a higher price than what would occur in a competitive market.

The deadweight loss is represented graphically as the area between the supply and demand curves that is not part of consumer or producer surplus. This inefficiency is a social cost as it represents a loss of total surplus.

Industry Concentration

Industry concentration refers to the extent to which a few firms control a significant share of the total market. High industry concentration can lead to reduced competition, resulting in higher prices, lower output, and less innovation.

In the case of the blocked US Foods and Sysco merger, the industry concentration would have increased significantly, leading to monopoly power and potential harm to the competitive landscape. The judge's decision to stop the merger was based on the desire to prevent these negative outcomes and to maintain a competitive market environment.