MARKETIMBA Managerial EconomicsJack Wu

PERFECT COMPETITION homogeneous product many buyers many sellers price takers free entry and exit equal information

FREE ENTRY?Japanese Beer Market, pre-’94:

Ministry of Finance production licenses for minimum of 2 million

liters a year sales licenses limited to small family-owned

stores

INFORMATIONMarket with differences in information not as competitive as one where all buyers and sellers have equal information

medical treatment legal advice

MARKET EQUILIBRIUM, IPrice at which quantity demanded equals quantity supplied when market out of equilibrium, market forces push price towards equilibrium

0

20

22

8 10 11

supply

demand

a

b

c

equilibrium

excess supply

Quantity (Million ton-miles a year)

Pric

e ($

per

ton-

mile

)

MARKET EQUILIBRIUM, II

MARKET EQUILIBRIUM, III

excess supply = excess of quantity supplied over quantity demanded triggers price decrease

excess demand = excess of qty demanded over qty supplied triggers price increase

SUPPLY SHIFT, I supply shifts down (right) -> lower price,

larger quantity supply shifts up (left) -> higher price, smaller

quantity final equilibrium depends on elasticities of

demand and supply

0

19.6020

10 10.4

original supply

new supply

demand60 cents

60 cents

c e

b

d

Quantity (Million ton-miles a year)

Pric

e ($

per

ton-

mile

) a

SUPPLY SHIFT, II

0 10

19.40

20

original supply

new supply

demand

60 cents

60 centsc

b

0 10 10.6

20 new supply

original supply

demand

60 cents

60 centsb

c

Extremely inelastic demand Extremely elastic demand

Quantity (Million ton-miles a year) Quantity (Million ton-miles a year)

Pric

e ($

per

ton-

mile

)

Pric

e ($

per

ton-

mile

)

e e

PRICE ELASTICITIES OF DEMAND

0

20

10

demand

a

b

original and new supply

0 10 11

19.4020 60 cents 60 cents

a

b original supply

new supply

demand

Pric

e ($

per

ton-

mile

)

Pric

e ($

per

ton-

mile

)

Quantity (Million ton-miles a year) Quantity (Million ton-miles a year)

Extremely inelastic supply Extremely elastic supply

PRICE ELASTICITIES OF SUPPLY

SUPPLY SHIFT: PRICE IMPACT price change no more than amount of the

supply shift price change

smaller if demand is more elastic than supply larger if supply is more elastic than demand

0

1.50

1

retail supply

a

Quantity (Million units a year)

Price

($ p

er u

nit)

after wholesale price cut

retail demandb

PROMOTING RETAIL SALES

Q

DEMAND SHIFT, I demand shifts down (left) -> lower price,

lower quantity demand shifts up (right) -> higher price,

larger quantity final equilibrium depends on elasticities of

demand and supply

0

20

10 10.8

supply

new demand

original demand

1 million

af

b

c

1 million

Quantity (Million ton-miles a year)

Pric

e ($

per

ton-

mile

)DEMAND SHIFT, II

TANKER SERVICES, 1999 OPEC production cutback

reduced demand for tanker services raised tanker operating cost on balance, reduced tanker rates

rates for older tankers fell more than for newer vessels

VALENTINE’S DAYNearing Valentine’s Day, price of roses always rises much more than the price of greeting cards. Why?

CALCULATING EQUILIBRIUM, IHow would 3% increase in income affect price and sales of gasoline? demand

price elasticity -.23 income elasticity 0.39

supply price elasticity 0.62

CALCULATING EQUILIBRIUM, II1. % change in qty demanded = -0.23 %p

+ 0.39 x 32. % change in qty supplied = 0.62 %p3. equate and solve: %p = 1.38%4. % change in qty = 0.87%

0

20

22

100105

price

short-runaveragevariable cost

short-runmarginal cost

Quantity (Thousand ton-miles a year) Quantity (Thousand ton-miles a year)

0

2022

10

12

short-rundemand

short-runsupply

1 million

a

c

Pric

e ($

per

ton-

mile

)

Pric

e ($

per

ton-

mile

)

(a) Individual seller (b) Market

SHORT-RUN MARKET EQUILIBRIUM

0

2021

100

original long-run averagecost

new long-runaverage cost

long-runmarginal cost

Quantity (Thousand ton-miles a year) Quantity (Thousand ton-miles a year)

0

2021

10

13

long-rundemand

long-runsupply1 million

a

d

Pric

e ($

per

ton-

mile

)

Pric

e ($

per

ton-

mile

)

(a) Individual seller (b) Market

LONG-RUN MARKET EQUILIBRIUM

SHORT/LONG-RUN IMPACTIf demand/supply shifts, market price is more volatile in the short run

than long run greater change in market quantity over the

long run than short run

PRICING AND FREIGHT COST, I cost and freight ex-works pricing

How does pricing policy affect sales?

0

1.50

1

CF supply

a

Quantity (Million pounds a year)

Pric

e ($

per

pou

nd)

ex-works supply

CF demand

ex-works demand

b

25 cents25 cents

PRICING AND FREIGHT COST, II

RETAILING: WHY COUPONS? alternative -- cutting wholesale prices “With coupons, prevent retailers from getting

part of price cut.”

DISCUSSION QUESTION 1 Manufacturers of paper products are major

buyers of waste paper. They use a combination of wood pulp and waste paper to produce paper products. The supply of waste paper comes from households and businesses. An issue in environmental policy is the effectiveness of price incentives in encouraging recycling of waste paper. The price elasticity of the demand for waste paper has been estimated to be -0.07, while the price elasticity of the supply has been estimated to be 0.

DISCUSSION QUESTION 1:CONTINUED Consider a government policy that reduces the

price of wastepaper to manufacturers by 5%. How would this affect the quantity demanded?

Consider a government policy that increases the price of wastepaper to sellers by 5%. How would this affect the quantity supplied?

Are price incentives an effective way of increasing the recycling of wastepaper?

DISCUSSION QUESTION 2 Industry researchers R.S. Platou predicted

that, between 2003 and 2004, oil prices would fall by 5%, production of oil by OPEC and the former Soviet Union would increase, and deliveries of new tankers would exceed scrappage of older vessels.

DISCUSSION QUESTION 2:CONTINUED (a)Uisng suitable diagrams, explain how each

of the following would affect the market for tanker services: (i) fall in oil prices; (ii) increase in production by OPEC and the former Soviet Union; (iii) new tanker deliveries; and (iv) scrappage of older vessels.

(b)Suppose that the net effect is to increase tanker rates. Illustrate the net effect on a single diagram. Explain the impact on the quantity of tanker services used.