Market Equilibrium and Market Demand: Perfect Competition

1
MarketEquilibrium and Market DemandPerfect
Competition

• Chapter 8

2
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
• 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

3
Firms supply curve starts at shut down level of
output
Page 123
4
Profit maximizing firm will desire to
produce where MCMR
Page 162
5
Economic losses will occur beyond output OMAX,
where MC gt MR
Page 162
6
Building the Market Supply Curve


Market supply curve can be thought of as the
horizontal summation of the supply decisions of
all firms in the market. Here, at a price of
1.50, Gary would supply 2 tons of broccoli and
Ima would supply 1 ton, giving a market supply
of 3 tons.
Page 163
7
MARKET SUPPLY SCHEDULE
P

• Quantity
• Point Price Supplied
• A 1 2
• B 2 3
• C 3 6
• D 4 8

D
C
B
A
Q
8
Own-Price elasticity of supply

9
Calculate own-price elasticity of supply between
2 and 3.
10
ELASTIC 1 DP gives rise to a 1.66 DQ in quantity
11
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.
Page 165
12
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. Total economic surplus is
therefore equal to consumer surplus discussed in
Chapter 4 plus producer surplus.
Page 165
13
Market Price of 4
Product price
Producer surplus at 4 is equal to area ABC
F
G
Page 165
14
Total revenue at 4 would be area 0ABF while
total cost would be area 0CBF. Thus Profit
area 0ABF-area 0CBF
Product price
C
F
G
Page 165
15
Total revenue at 4 would be area 0ABF while
total cost would be area 0CBF. Thus Profit
area 0ABF-area 0CBF
Product price
Area 0ABF can be found by multiplying price
time quantity, or 4 times output F
C
F
G
Page 165
16
Suppose Price Increased to 6
Product price
Producer surplus at 6 is equal to area EDC
F
G
Page 165
17
Total revenue at 6 would be area 0EDG while
total cost would be area 0CDG. Thus profit would
be area 0EDG minus area 0CDG, or CED.
Product price
C
F
G
Page 165
18
The gain in producer surplus if the price
increases from 4 is equal to area AEDB
Producers are better off economically
by responding to this price increase by producing
output G
C
F
G
Page 165
19
(No Transcript)
20
Some Important Jargon
We need to distinguish between movement along a
demand or supply curve, and shifts in the demand
or supply curve.
21
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 change in demand or supply.
22
Increase in demand pulls up price from Pe to Pe
Decrease in demand pushes price down from Pe to
Pe
Page 167
23
Decrease in supply pulls up price from Pe to Pe
Increase in supply pushed price down from Pe to
Pe
Page 167
24
Economic Welfare Concepts
We can use the concepts of market demand and
supply to assess the effects of events in the
economy have upon the economic well being of
consumers and products in a particular
market. We do this using the concept of
consumer surplus introduced in Chapter 4
with producer surplus discussed here.
25
ECONOMIC SURPLUS
Economic Surplus Consumer Surplus Producer
Surplus Consumer Surplus area 1, Producer
Surplus area 2
26
An Example of Economic Welfare Analysis
Assume a drought occurs that results in a
decrease in supply from S to S. Before this
happened, consumer surplus was area 345 while
producer surplus was equal to area 67.
Page 169
27
An Example of Economic Welfare Analysis
After the decrease in supply, consumer surplus is
just area 3. They lose area 4 and area
5. Producers gain area 4 but lose area 7.
Page 169
28
An Example of Economic Welfare Analysis
Consumers are therefore worse off because of
the drought. Producers are also worse off if
area 4 is less than area 7. Society loses
area 57.
Page 169
29
CHANGE IN ECONOMIC SURPLUS
? in economic surplus -4-57 -5-7
30
Measuring Surplus Levels
D
7
Consumer surplus is equal to (10 x (7-4))2, or
15
S
Product price
4
1
10
Page 169
31
Measuring Surplus Levels
D
7
Consumer surplus is equal to (10 x (7-4))2, or
15
S
Product price
4
Producer surplus is Equal to (10 x (4-1))2, or
15
1
10
Page 169
32
Measuring Surplus Levels
D
7
Consumer surplus is equal to (10 x (7-4))2, or
15
S
Product price
4
Producer surplus is Equal to (10 x (4-1))2, or
15
1
10
Total economic surplus is therefore 30
Page 169
33
Market Disequilibrium
34
Market Surplus
If the price is PS, producers would supply QS
while consumers would only want QD at this high
price.
Page 170
35
Market Shortage
If the price is PD, producers would only supply
QD while consumers want QD at this low price.
Page 170
36
Adjustments to Market Equilibrium
Markets converge to equilibrium over time unless
other events in the economy occur. One
explanation for this adjustment which makes sense
in agriculture is the Cobweb theory. This names
stems from the spider like trail the adjustment
process makes.
37
Year Two Reactions
Producers use last years price as their
expected price for year 2. Consumers on the
other hand pay this years price determined by
Q2.
Page 172
38
Year Three Reactions
P3
P2
Producers now decide to produce less at the
lower expected price. This lower quantity
pushes price up to P3 in year 3.
Page 172
39
Cobweb Pattern Over Time
Market equilibrium
The market converges to market equilibrium
where demand intersects supply at price PE. In
some markets, this adjustment period may only be
months or even weeks rather than years assumed
here.
Page 172