Technical Note: Optimal Market Integration Decisions by Policy Makers: Modeling and Analysis of Agriculture Market Data

Abstract

Policy-makers often seek to integrate markets as a way to maximize social welfare. Prior research has examined the effect of market integration on social welfare (surplus) only at two extremes -- when the markets are fully integrated, or, when they are fully isolated. But there is scarce information available for (i) how large the social surplus is at intermediate levels of market integration, and (ii) whether social surplus is maximized when markets are fully integrated, or fully isolated, or partially integrated. In this note, we consider the spectrum of all possible integration policies spanning from full isolation to complete integration, and characterize the socially-optimal market integration, under general demands. Our setting consists of a policy-maker, a price-setting firm, and a continuum of consumers in two markets. We identify market conditions under which social surplus is indeed maximized at partial market-integration. For the linear price-responsive demand model that is used extensively in the operations management literature, these conditions are identified as thresholds on (i) the relative size of the markets being integrated, and, (ii) the relative price-sensitivity of consumers in these markets. We then apply the model to the commercial seed market in European Union (EU). We first identify the optimal level of market integration between the markets for seed corn in various countries in EU. Subsequent analysis shows that socially-optimal market integration for these countries provides a further improvement in the social surplus for EU by 2.80%, relative to complete integration. Overall, our results show that policy-makers should exercise caution in determining the extent to which markets are integrated.