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Market Equilibrium and Market Demand: Perfect Competition Chapter 8

Market Equilibrium and Market Demand: Perfect Competition

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Market Equilibrium and Market Demand: Perfect Competition. Chapter 8. Chapter 8 - Topics of Discussion. DERIVATION OF THE MARKET SUPPLY CURVE Firm Supply Curve -- Own-Price Elasticity of Supply Market Supply Curve -- Producer Surplus MARKET EQUILIBRIUM UNDER PERFECT COMPETITION - PowerPoint PPT Presentation

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Page 1: Market Equilibrium  and  Market  Demand: Perfect Competition

Market Equilibrium and Market Demand:

Perfect Competition

Chapter 8

Page 2: Market Equilibrium  and  Market  Demand: Perfect Competition

DERIVATION OF THE MARKET SUPPLY CURVE◦ Firm Supply Curve -- Own-Price Elasticity of Supply◦ Market Supply Curve -- Producer Surplus

MARKET EQUILIBRIUM UNDER PERFECT COMPETITION◦ Market Equilibrium◦ Total Economic Surplus◦ Applicability to Policy Analysis

ADJUSTMENTS TO MARKET EQUILIBRIUM◦ Market Disequilibrium -- Market Shortage◦ Market Surplus -- Length of Adjustment Period◦ Cobweb Adjustment Cycle

Chapter 8 - Topics of Discussion

Page 3: Market Equilibrium  and  Market  Demand: Perfect Competition

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Firm’s supply curvestarts at shut downlevel of output

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Profit maximizing firm will desire to producewhere MC=MR

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Economic losses will occurbeyond output OMAX, whereMC > MR

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Market supply curve can be thought of as the horizontal summationof the supply decisions of all firms in the market. Here, at a priceof $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons.

+ =

Page 132

Building the Market Supply Curve

Page 7: Market Equilibrium  and  Market  Demand: Perfect Competition

MARKET SUPPLY SCHEDULE

0

1

2

3

4

2 3 6 8

QuantityPoint Price Supplied A 1 2 B 2 3 C 3 6 D 4 8 A

B

C

DP

Q

Page 8: Market Equilibrium  and  Market  Demand: Perfect Competition

Own-Price elasticity of

supply

)2/)/(()()2/))/(()(

BABA

SBSASBSA

PPPPQQQQ

=

Page 9: Market Equilibrium  and  Market  Demand: Perfect Competition

Calculate own-price elasticity of supply between $2 and $3.

DQ P

DP QX

DQ = 3, DP = 1, Q = 4.5, P = 2.5

Page 10: Market Equilibrium  and  Market  Demand: Perfect Competition

DQ P

DP QX3 2.5

1 4.5X = 1.66 =

ELASTIC

1% DP gives rise to a 1.66% DQ in quantity

Page 11: Market Equilibrium  and  Market  Demand: Perfect Competition

Concept of Producer Surplus

Producer surplus is a fancy term economists use for profit. We measure producer surplus as the area above the supply curve and below the market equilibrium price.

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Page 12: Market Equilibrium  and  Market  Demand: Perfect Competition

Concept of Producer Surplus

Producer surplus is a fancy term economists use for profit. We measure producer surplusas the area above the supply curve andbelow the market equilibrium price.

Total economic surplus is therefore equal toconsumer surplus discussed in Chapter 4plus producer surplus.

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Producer surplus at $4is equal to area ABC

F G

Product price

Market Price of $4

Page 14: Market Equilibrium  and  Market  Demand: Perfect Competition

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F G

Total revenue at $4 would bearea 0ABF while total costwould be area 0CBF. ThusProfit = area 0ABF-area 0CBF

Product price

C

Page 15: Market Equilibrium  and  Market  Demand: Perfect Competition

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F G

Total revenue at $4 would bearea 0ABF while total costwould be area 0CBF. ThusProfit = area 0ABF-area 0CBF

Product price

Area 0ABF can be foundby multiplying price timequantity, or $4 times output FC

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F G

Producer surplus at $6is equal to area EDC

Product price

Suppose Price Increased to $6

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F G

Total revenue at $6 would bearea 0EDG while total costwould be area 0CDG. Thusprofit would be area 0EDG minus area 0CDG, or CED.

Product price

C

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The gain in producer surplus if the price increases from $4is equal to area AEDB

F G

Producers are betteroff economically byresponding to thisprice increase byproducing output G

C

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Page 20: Market Equilibrium  and  Market  Demand: Perfect Competition

Some Important JargonWe need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve.

Page 21: Market Equilibrium  and  Market  Demand: Perfect Competition

Some Important Jargon

We need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve.

Movement along a curve is referred to as a“change in the quantity demanded or supply”. A shift in a curve is referred to as a “changein demand or supply”.

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Increase in demandpulls up price from Pe to Pe*

Decrease in demandpushes price downfrom Pe to Pe*

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Increase in supplypushed price down from Pe to Pe*

Decrease in supplypulls up price from Pe to Pe*

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Economic Welfare Concepts

We can use the concepts of market demandand supply to assess the effects of eventsin the economy have upon the economicwell being of consumers and products ina particular market.

We assess these effects using the concept of Consumer surplus introduced in Chapter 4 with producer surplus discussed here.

Page 25: Market Equilibrium  and  Market  Demand: Perfect Competition

ECONOMIC SURPLUS

Economic Surplus = Consumer Surplus + Producer Surplus

Consumer Surplus = area #1, Producer Surplus = area #2

Page 26: Market Equilibrium  and  Market  Demand: Perfect Competition

An Example of Economic Welfare Analysis

Assume a drought occursthat results in a decreasein supply from S to S*.

Before this happened,consumer surplus wasarea 3+4+5 while producersurplus was equal toarea 6+7.

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An Example of Economic Welfare Analysis

After the decrease insupply, consumer surplusis just area 3. They lose area 4 and area 5.

Producers gain area 4 butlose area 7.

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Page 28: Market Equilibrium  and  Market  Demand: Perfect Competition

An Example of Economic Welfare Analysis

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Consumers are thereforeworse off because of thedrought.

Producers are also worse off if area 4 is less than area 7.

Society loses area 5+7.

Page 29: Market Equilibrium  and  Market  Demand: Perfect Competition

CHANGE IN ECONOMIC SURPLUS

Δ in economic surplus = -4-5+7 = -5-7

Page 30: Market Equilibrium  and  Market  Demand: Perfect Competition

Measuring Surplus Levels

Product price

DS

$4

10

$1

$7 Consumer surplus isequal to (10 x (7-4))÷2,or $15

Page 31: Market Equilibrium  and  Market  Demand: Perfect Competition

Measuring Surplus Levels

Product price

DS

$4

10

$1

$7 Consumer surplus isequal to (10 x (7-4))÷2,or $15

Producer surplus isEqual to (10 x (4-1))÷2,or $15

Page 32: Market Equilibrium  and  Market  Demand: Perfect Competition

Product price

DS

$4

10

$1

$7 Consumer surplus isequal to (10 x (7-4))÷2,or $15

Producer surplus isEqual to (10 x (4-1))÷2,or $15

Total economic surplusis therefore $30…

Measuring Surplus Levels

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Market Disequilibrium

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Market Surplus

If the price is PS, producers wouldsupply QS whileconsumers wouldonly want QD atthis high price.

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Page 35: Market Equilibrium  and  Market  Demand: Perfect Competition

Market Shortage

If the price is PD, producers wouldonly supply QD while consumers want QD at thislow price.

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Adjustments to Market Equilibrium

Markets converge to equilibrium over time unless other events in the economy occur.

One explanation for this adjustment whichmakes sense in agriculture is the Cobwebtheory. This name stems from the spiderlike trail the adjustment process makes.

Page 37: Market Equilibrium  and  Market  Demand: Perfect Competition

Year Two Reactions

Producers use last year’sprice as their expectedprice for year 2.

Consumers on the otherhand pay this year’s price determined by Q2.

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Page 38: Market Equilibrium  and  Market  Demand: Perfect Competition

Year Three Reactions

P2

P3

Producers now decide toproduce less at the lowerexpected price. Thislower quantity pushesprice up to P3 in year 3.

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Page 39: Market Equilibrium  and  Market  Demand: Perfect Competition

Cobweb Pattern Over Time

Marketequilibrium

The market converges tomarket equilibrium wheredemand intersects supplyat price PE. In some markets, this adjustmentperiod may only be monthsor even weeks rather thanyears assumed here.

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