Credit-Product Interlinkage and Captive Markets in Backward Agriculture : A Theoretical Analysis

This paper builds a model of fragmented duopsony in backward agriculture following Basu and Bell (1991) in which the purchasers (traders) have captive markets each but compete in a contested market. We focus on the formation of captive markets through trader-farmer interlinkage in the form of interlinked credit-product contracts (ICPCs). ICPC (or the formation of captive markets) is not an entry-preventive strategy in the model. Its motive is to push the farmers to their reservation income level. However, the captive and the contested markets are linked by the requirement that the reservation income of a captive farmer has to equal the income of a farmer in the contested market. In general, in our model strategic considerations determine the extent of use of ICPCs rather than explaining their existence. (In a special case, however, they do explain existence.) We also show that a credit subsidy policy will reduce the size of the captive market, improve the welfare of the farmers and raise the agricultural productivity of the economy while the effects of a price subsidy policy will be ambiguous