Demand analysis

Firms sell goods/services to buyers Consumers (individuals) : utility Firms : make profits

Willingness to pay: maximum price buyer will pay for a good Point of indifference between buying and not

buying Lower price always preferred by buyer

Willingness to pay is determined by Buyer’s tastes or needs Income and wealth

Normal/inferior goods Cyclical/acyclical demand

Substitutes Complementary goods

Demand curve for an individual buyer Willingness to pay for

different quantities of the good Or, quantity demanded at each

price Usually downward sloping:

lower willingness to pay for additional units Lower utility of consumption

for consumers Lower productivity of

resources for firms

Shifts in demand curve

Market demand Sum of individual demand curves Aggregate quantity demanded at each price Arrays individual buyers in order of willingness to pay Identical goods? Product differentiation?

Market segments / Price discrimination Different segments willing to pay different prices Consumer surplus Can firms exploit this?

Feasible? Fair?

Price sensitivity of demand Slope of market demand curve Flat demand curve: very price sensitive: Elastic

Goods with good substitutes Luxury items ?

Steep demand curve: less sensitive: Inelastic Necessities

Time-frame: easier to find substitutes over long run

Demand curves Accept as given? Seek to modify?

Supply analysis

Supply curve How much the firm will sell at each price Assumption: price-taking firm

Time-frame of supply decision Long run: compete in the market at all? Short run: how much to produce & sell?

Short run supply Based on costs

Fixed costs: incurred regardless of volume ‘headquarter’ costs, depreciation, rent, labor….

Variable or marginal costs: cost per additional unit produced Raw materials, electricity, labor….

In the short run, fixed costs are inevitable Should not affect short run supply decisions (?)

Marginal costs Cash costs: out-of-

pocket Opportunity costs:

foregone profits

Marginal cost curve : Short run supply curve

Long run supply: entry & exit Recover both fixed and variable costs Fixed costs

Out-of-pocket costs Opportunity costs: return on capital

Shifts in supply curve Input costs Technology

Market supply curve Sum of individual supply curves Usually slopes upward

Less efficient firms enter market when price is high Arrays firms from most efficient to least

Market equilibrium

Interesection of market demand and supply curves

Disequilibrium will cause price to adjust and yield new equilibrium

Real world: series of small disequilibriums, series of price adjustments

Currency markets: rapid, continuous adjustments

Supply elasticity Flat supply curve: very sensitive to price: Elastic Steep supply curve: less sensitive: Inelastic

Varies over the range of output Elastic when spare capacity is available Inelastic when capacity constrained

Profit calculation based on equilibrium price

Average and marginal costs

Marginal cost determines supply volume

Average costs at that volume

Market adjustment

Shifts in demand and supply curves Increase: shift to the right Decrease: shift to the left

Impact on quantity and price

Inelastic curves: adjustment largely through price Elastic curves: adjustment largely through quantity Short run versus long run

Perfect competition

Three assumptions:1. Identical products

2. Many small price-taking buyers and sellers

3. Full information

Excess profits more firms enter increased supply lower price zero excess profits

Three more conditions:

1. Identical sellers

2. Free entry

3. Free exit

Zero excess profits Long run

profitability?

Departures from perfect competition

Most markets have far from perfect competition Exceptions: commodities

Secret of long run profitability: deviations from perfect competition

Few sellers or buyers Extreme case: monopoly or monopsony Oligopoly

Collusion Cartels: incentives to cheat the cartel

Societal impact: anti-trust regulation

Entry and exit barriers First mover advantage

Headstart on learning curve Economies of scale Reputation and branding

High exit costs May lead to firms accepting sustained losses

Product differentiation Special attributes: Real or imaginary

Differences among sellers Least cost producer Innovation

Imperfect information Search costs protect

existing relations and discourage competition