Microeconomics: Strategic Interaction Dr Hamish Low

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MicroeconomicsStrategic InteractionDr Hamish
Low

• Lecture 2

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Outline

• Demand and supply curves
• Equilibrium
• Earnings Maximisation (Efficiency)
• Effect of taxes
• Economic Analysis

3
Valuations
Sellers 2, 2, 3, 3, 4, 5, 6, 6, 7,
8 Buyers 10, 10, 9, 9, 8, 7, 6 , 6, 5,
4
4
Price
7
6.5
Market on your right
6
5.5
5
4.5
Round
1
2
3
Price
7
6.5
6
Market on your left
5.5
5
4.5
Round
1
2
3
5
Issues
Sellers 2, 2, 3, 3, 4, 5, 6, 6, 7,
8 Buyers 10, 10, 9, 9, 8, 7, 6 , 6, 5,
4

• who would be willing to trade more units at a
  price of 5? Buyers or sellers?
• Does the excess of buyers raise or lower the
  price from the initial price of 5?
• How high does the price have to go to eliminate
  the excess demand?
• What if initial price is 7?
• Demand must equal supply for equilibrium.

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Draw demand and supply curves
Demand curve
Price
Supply curve
Quantity
7
Draw demand and supply curves
Demand curve
Price
Supply curve
Quantity
8
Observed Prices
Observed Equilibrium
Demand curve
10
Price
8
Round 1 (LHS)
6
4
Supply curve
2
2
4
6
8
10
Quantity
9
8
Market on your right
7
6
5
4
1
2
3
4
8
7
6
Market on your left
5
4
1
2
3
4
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Earnings Maximisation

• Does the market extract all of the gains from
  trade?
• What is maximum earnings?
• 34

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Efficiency / Collusion
RED
Earnings in round 4 for buyers and
sellers 17 GREEN Earnings in round 4 for
buyers and sellers Sellers 16.50 Buyers
17.50
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Earnings Maximisation (cont)

• Which traders are likely to make the initial
  deals?
• Would forcing any extra trades lead to greater
  earnings?
• Inefficiency is caused by price dispersion
• How to improve efficiency?

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Effect of Taxes
Demand curve
Price
New Supply curve
Supply curve
Quantity
15
Market on your right
Market on your left
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Effect of Taxes
Price
Quantity
17
Imposing a Tax
2 tax on sellers. Average price increased -
by 0.875 on both sides Formal incidence of tax
does not determine who actually pays. Depends
on slopes of demand and supply curves
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Rationality

• Rational decision making
• Acting as if optimising
• Should be optimising

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Optimisation
Rational
Observed Behaviour
Empirical
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Many utility functions can be used to represent
the same preferences
Prefer 1 apple to 1 banana
Only ordinal information
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Conclusions

• Market can find the equilibrium price with only a
  few competitors with limited information.
• Price is reached quickly
• Tax incidence distinct from formal incidence
• Interaction here is competitive
• Economics as an empirical social science