Microeconomic analysis of parallel markets

JOURNAL

OF COMPARATIVE

ECONOMICS

12,604-609

(1988)

COMMENT Microeconomic

Analysis of Parallel Markets

DANIELP. RICHANDMICHAELL.

WYZAN

Illinois State University, Normal, Illinois 61761 Received May 12, 1988 Rich, D.P., and Wyxatt, M.L.-Microeconomic

Analysis of Parallel Markets

We examine the conditions under which estimating retail demand in planned economies via the relationship between parallel-market price and combined parallel- and official-market output is valid. We find that these conditions hold to differing extents for Soviet meat and milk. J. Camp. Econom. December 1988, 12(4), pp. 604-609. Illinois state University, Normal, Illinois 6 176 1. 0 1988 Academic Press, hc. Journal of Economic Literature Classification Numbers: 052, Ill,

92 1.

1. INTRODUCTION In a recent article, Alexeev (1987) provides a rare attempt to construct a theoretical model of individual behavior under one of the most striking aspects of the Soviet economy-the dualism of the official and parallel retail markets for agricultural products. He goes on to estimate, using official Soviet data, demand functions for meat and milk for 1958-1980. Alexeev provides a novel approach to an important topic on which little research has been conducted thus far. Moreover, we are grateful to him for presenting his data, especially his series of collective-fatm market (CPM) prices. Unfortunately, we must take issue with several aspects of his paper. His theoretical section fails to distinguish between individual- and market-level phenomena and is thus weakly related to the empirical work which follows. The validity of his empirical work depends on the realism of several problematic assumptions. We carry out a simple empirical procedure, the results of which suggest limitations to the general applicability of his econometric strategy. 2. COMMENTS

ON THE MODEL

Alexeev’s theoretical work depends critically on an expected full-price constraint which has been employed extensively in the literature on markets for Ol47-5967/88f53.00 Copyright 0 1988 by Academic Press, Inc. All rights of reproduction in any form r-served.

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products with important qualitative variation due to service delays (De Vany and Saving, 1983). For any particular product, the decisions of consumers are based on its “full price” P, = p1 + 10,

(1)

where p1 is the money price, 2, is consumers’ monetary value of time, and t represents the expected waiting time per unit of the product. In Soviet retail agricultural markets a given product which is available for p1 on the official market with t > 0 may also be found on the rynok, i.e., the collective-farm market, for p2 with zero expected delay. Under certain conditions, discussed below, equilibrium is obtained where p2 = P2 = P, = p1 + t&J.

(2)

In Eq. (2), the expected waiting time adjusts to te, the equilibrium value at which the full price on the CFM (P2) equals the full price on the official market. Note that in equilibrium the CFM money price conveys useful information concerning both markets. Although Eq. (2) applies at the market level, Alexeev employs this constraint in the utility-maximization problem of the individual consumer. This marketequilibrium condition holds only for the marginal consumer, who is indifferent between the two means of obtaining the good. All other consumers are not so indifferent, and reveal their preferences through their observed behavior. In Alexeev’s model, an individual’s wage rate is taken as his marginal value of time. He justifies the application of Eq. (2) at the individual level by arguing that “[e]quilibrium is attained only when” wages are equal across all consumers (p. 547). From a theoretical standpoint, this assertion is difficult to accept; what is the process through which the market for milk or meat eliminates wage differences? Empirically, substantial wage differentials in Soviet labor markets are an established fact (e.g., Gregory and Kohlhase, 1988, p. 24). Alexeev is correct in raising the issue of resale (Stahl and Alexeev, 1985, p. 240; Alexeev, 1987, p. 547). Individuals with sufficiently low marginal values of time (e.g., pensioners) have an incentive to join the queue and purchase amounts in excess of their own consumption for resale to those with relatively high values of time (e.g., enterprise managers). If significant activity of this sort takes place Eq. (2) is not valid, even at the market level. The extent to which p2 conveys useful information regarding the official market under these conditions is unclear. Alexeev implies that wage differentials are eliminated, and the validity of Eq. (2) preserved, by the possibility of resale. However, it is the absence of resale that preserves the applicability of the Ml-price constraint. The feasibility of resale for Soviet agricultural products is limited by the harsh penalties for such “speculative” activity (Katsenelinboigen, 1977, p. 8 l), by the rationing

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process, and by the highly perishable nature of the products in question. These factors may make the imposition of a market full-price constraint appropriate for this particular application. 3. COMMENTS

ON ESTIMATION

We are aware of very few studies that have attempted to estimate demand curves for Soviet consumer goods. An important barrier to econometric studies in this area has been that official retail prices for several agricultural products have remained unchanged for many years. Alexeev provides market-level demand estimates over 1958-1980 for Soviet meat and milk, whose prices were last raised in 1962 (Bomstein, 1987, p. 119). Perhaps Alexeev’s chief contribution is to suggest a context within which such estimates could be valid. We have argued that, under certain conditions, Eq. (2) holds at the market level; therefore, our concerns about imposing the full-price constraint at the individual level should not be construed as critical of Alexeev’s empirical section. Indeed, when the full-price constraint is valid, regressing the money CFM price against the sum of the quantities from the two markets provides useful information. Under these conditions, the full-price elasticity common to both goods is equivalent to the money price elasticity of either good. The question remains: under what conditions is the market full-price constraint valid? First, as discussed above, there should be no significant resale of units of the product bought at the lower price. We have argued that this may well hold for the Soviet markets for meat and milk. One must be careful, however, in applying this empirical strategy in contexts where resale is feasible. Second, the product must also be homogeneous between the two markets (Alexeev, 1987, p. 544). The applicability of Eq. (2) depends on the assumption that the two goods are qualitatively identical, with the exception of length of service delay. It is generally accepted that fruits and vegetables available on the CFM in socialist countries are of higher quality than their official counterparts. The same may be said of certain types of meat. Private producers are more likely to use grain as feed than to follow the social-sector practice of putting animals out to pasture. Differences in the taste of the meat reportedly result from this variation in feeding practices. Thus, it is not entirely clear that product homogeneity can be relied on even in the present context. Finally, there is an important econometric issue that must be mentioned. Alexeev is aware that “a structural model involving simultaneous equations would be necessary in order to obtain unbiased estimates of the demand curve parameters” unless the CFM supply curve is vertical (p. 550). His case rests on per household restrictions on livestock numbers, as though supply curves cannot be positively sloped in the presence of a single fixed factor.

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Hedlund and Lundahl (1982), among others, provide a theoretical basis for a positive relationship between prices and quantities supplied on the CFM. A higher price for privately produced products will affect the peasant household’s decision as to how to divide its members’ time among three distinct activities-private work, state-sector work, and leisure. Moreover, the long history of state-peasant relations in socialist countries suggest that grain production is not synonymous with grain marketings. Clearly, private farmers respond to price signals. Endogeneity is particularly relevant here because CFM output varies not only in response to exogenous changes in full-price demand and own supply, but also in response to variation in official production levels. For example, higher levels of social-sector output will increase “combined supply” (Alexeev, 1987, p. 549), leading to reduced & and a lower equilibrium full price. By Eq. (2), this produces a decline in CFM money price to which private producers respond by reducing CFM quantity supplied. In the presence of a nontrivial price elasticity of CFM supply, estimated demand elasticities do not conform to the interpretation suggested by theory. We have argued that Alexeev’s empirical strategy is valid if there is no significant resale, the product is homogeneous, and the CFM market supply curve is vertical. Ideally, one would test each of the assumptions a priori. We realize, however, that data limitations restrict one’s ability to model the supply behavior of the collective-farm sector. Nonetheless, there is a simple alternate estimation procedure that permits us to check the validity of his approach. Under the aforementioned three conditions, the estimated full-price elasticity of demand is not sensitive to whether the model is specified with two separate output terms (CFM and official) or with only their sum. Although the sharp distinction between the private and socialist agricultural sectors has been blurred since 198 1 (Wadekin, 1988), separate data by sector are available through 1980. We respecify Alexeev’s demand equation (p. 55 1) to make use of these data. Table 1 contains a comparison of alternate methods of estimating the fullprice elasticities for meat and milk. The estimates in the A column are taken directly from his Table 1 (p. 553), and those in the RW 1 and RW2 are based on our own empirical work. Under the maintained assumptions, the coefficients on official and private output in RW2 should be identical and equal to the coefficient on combined output in RW 1. For meat, a statistical test for equality of the coefficients on the two output variables in RW2 strongly sup ports the use of combined output (I; 1.~7= 0.003). On the other hand, in the milk equation the coefficients on these two variables are not even of the same sign, and the F statistic (F,,,, = 3.488) would lead us to reject equality between the coefficients at 0.08. These results indicate that the use of combined output may not be appropriate in all circumstances. Of course, we have not rectified the problem of

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RICH AND WYZAN TABLE 1 JZSTIMATESOFFULL-PRICE

Variable

A”

DEMANDS

RWlb

RW2b

-1.877 (-1.240)

- 1.694 (-0.913)

Product: Meat Constant Combined output

1.12** (3.53) -0.041’. (-2.95)

-0.183** (-3.277)

Official output

-0.172’ (-2.006)

Private output

-0.212 (-1.249)

Average wage

0.022** (8.19)

0.019** (4.690)

0.019, (4.22 1)

0.015 (1.664)

0.015 (1.523)

0.943

0.940

0.39** (4.42)

-0.017 (-0.058)

-0.830 (-1.620)

-0.0012** (-3.27)

-0.006** (-3.512)

Population Adjusted R2

0.94 Product: Milk

Constant Combined output Official output

-0.011** (-3.579)

Private output

0.005 (0.800)

Average wage

0.0026** (9.16)

Population Adjusted R2

0.89

0.003** (4.186)

0.003** (4.840)

0.001 (1.053)

0.005* (2.068)

0.889

0.902

Note. Dependent variable: Collective-farm market price a All estimates are derived via OLS ’ Alexeev’s output variable is in per capita terms and for meat includes both domestic production and net meat imports. Our output variables are not in per capita terms--although we include population as a separate regressor-and include only domestic production for both products. We employ his CPM price and average wage data. All new data are found in Nurkhoz. ‘I statistics are in parentheses. * The coefficient on the relevant variable is significant at 0.05. ** The coefficient on the relevant variable is significant at 0.0 1.

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potential simultaneous-equations bias. Nonetheless, future empirical work on parallel markets should employ preliminary tests of this nature before assuming that the full-price constraint holds. REFERENCES Alexeev, Michael, “Microeconomic Modeling of Parallel Markets: The Case of Agricultural Goods in the USSR.” J. Comp. Econom. 11,4:543-557, Dec. 1987. Bomstein, Morris, “Soviet Price Policies.” Soviet Econom. 3,2:96-134, Apr.-June, 1987. De Vany, Arthur, and Saving, Thomas, “The Economics of Quality.” J. Polit. Econom. 91, 6: 979-1000, Dec. 1983. Gregory, Paul, and Kohlhase, Janet, “The Earnings of Soviet Workers: Evidence from the Soviet Interview Project.” Rev. Econom. Statist. 70, 1:23-35, Feb. 1988. Hedlund, Stefan, and Lundahl, Mats, “Linking Efforts and Rewards: The ‘Zveno’ System of Collective Farming.” Econom. Plann. 18,2:7 l-84, 1982. Katsenelinboigen, Aron, “Coloured Markets in the Soviet Union.” Soviet Stud. 29, 1:62-85, Jan. 1977. Narodnoe Khoziaistvo SSSR. (referred to as Narhoz). Stahl, Dale, II, and Alexeev, Michael, “The Influence of the Black Markets on a Queue-Rationed Centrally Planned Economy.” J. Econom. Theory 35,2:234-250, Apr. 1985. Wadekin, Karl-Eugen, “Soviet Agriculture in 1987 and the Private Sector.” Radio Liberty Research, no. 110, Mar. 15, 1988.