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Market Equilibrium and Market Demand: Perfect Competition. Chapter 8. Discussion Topics. Derivation of market supply curve Elasticity of supply and producer surplus Market equilibrium under perfect competition Total economic surplus Adjustments to market equilibrium. Remember the firm’s

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Market equilibrium and market demand perfect competition

MarketEquilibrium and Market Demand:Perfect Competition

Chapter 8


Discussion topics
Discussion Topics

  • Derivation of market supply curve

  • Elasticity of supply and producer surplus

  • Market equilibrium under perfect competition

  • Total economic surplus

  • Adjustments to market equilibrium


Remember the firm’s

supply curve?

P=MR=AR

Page 123


P=MR=AR

Firm’s supply curve

starts at shut down

level of output

Page 162


Profit maximizing firm

will desire to produce

where MC=MR

P=MR=AR

Page 162


Economic losses will occur

beyond output OMAX, where

MC > MR

P=MR=AR

Page 162


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


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


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


Merging demand and supply
Merging Demand and Supply

Price

D

S

Market clearing price

PE

Quantity

QE


Merging demand and supply1
Merging Demand and Supply

Price

D

S

PE

Chapters 3-5

Quantity

QE


Merging demand and supply2
Merging Demand and Supply

Factors that change

demand:

  • Other prices

  • Consumer income

  • Tastes and preferences

  • Real wealth effect

  • Global events

D*

Price

D

S

PE*

PE

Quantity

QE*

QE


Merging demand and supply3
Merging Demand and Supply

Price

D

S

Chapters 6-7

PE

Quantity

QE


Merging demand and supply4
Merging Demand and Supply

S*

Factors that change

supply:

  • Input costs

  • Government policy

  • Price expectations

  • Weather & disease

  • Global events

Price

D

S

PE*

PE

Quantity

QE*

QE


Concept of producer surplus
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


Concept of producer surplus1
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


Market Price of $4

A

B

Product price

Producer surplus at $4

is equal to area ABC

F

G

Page 165


Suppose Price Increased to $6…

Product price

Producer surplus at $6

is equal to area EDC

F

G

Page 165


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


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 3+4+5 while producer

surplus was equal to

area 6+7. Total economic

equals area 3+4+5+6+7

Page 169


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


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 5+7.

Page 169


Measuring Surplus Levels

$7

D

Consumer surplus is

equal to (10 x (7-4))÷2,

or $15

S

$4

Product price

$1

10

Page 168


Measuring Surplus Levels

$7

D

Consumer surplus is

equal to (10 x (7-4))÷2,

or $15

S

$4

Product price

Producer surplus is

Equal to (10 x (4-1))÷2,

or $15

$1

10

Page 168


Measuring Surplus Levels

$7

D

Consumer surplus is

equal to (10 x (7-4))÷2,

or $15

S

$4

Product price

Producer surplus is

Equal to (10 x (4-1))÷2,

or $15

$1

10

Total economic surplus

is therefore $30…

Page 168


Modeling commodity prices
Modeling CommodityPrices


Forecasting Future Commodity Price Trends

$7

D

S

D = a – bP + cYD + eX

$4

Own

price

Other

factors

Disposable

income

$1

10

Page 168


Forecasting Future Commodity Price Trends

$7

D

S

Own

price

Input

costs

Other

factors

$4

S = n + mP – rC + sZ

$1

10

Page 168


Projecting Commodity Price

$7

D

S

D = 10 – 6P + .3YD + 1.2X

D = S

$4

S = 2 + 4P – .2C + 1.02Z

$1

10

Substitute the demand and supply

equations into the the equilibrium

condition and solve for price

Page 221


Many applications
Many Applications

  • Policy decisions by Congress and the president

  • Commodity modeling by brokers and traders

  • Credit repayment capacity analysis by lenders

  • Outlook presentations by extension economists

  • Planting decisions by farmers

  • Herd size and feedlot placement decisions by livestock producers

  • Strategic planning for processors



Market Surplus

At the price is PS,

producers would

supply QS.

Page 170


Market Surplus

At the price is PS,

consumers would

only want QD.

Page 170


Market Surplus

At the price is PS,

a market surplus

equal QS – QD exists

Page 170


Market Shortage

At the price is PD,

producers would

only supply QS.

Page 170


Market Shortage

Consumers

want QD at this

low price.

Page 170


Market Shortage

Consumers

want QD at this

low price.

At the price is PS,

a market shortage

equal QD – QS exists

Page 170


Adjustments to market equilibrium
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.


Year 2 Reactions

Producers use last year’s

price as their expected

price for year 2.

Consumers on the other

hand pay this year’s

price determined by Q2.

Page 172


Year 3 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


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



Some important jargon
Some Important Jargon

We need to distinguish between movement

along a demand or supply curve, and shifts

in the demand or supply curve.


Some important jargon1
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 supplied”.

A shift in a curve is referred to as a “change

in demand or supply”.


Increase in demand

pulls up price from

Pe to Pe*

Decrease in demand

pushes price down

from Pe to Pe*

Page 167


Decrease in supply

pulls up price from

Pe to Pe*

Increase in supply

pushed price down

from Pe to Pe*

Page 167


Merging demand and supply5
Merging Demand and Supply

Price

D

S

Chapters 6-7

PE

Chapters 3-5

QE

Quantity


Firm is a price taker under perfect competition
Firm is a “Price Taker” Under Perfect Competition

The Market

The Firm

Price

Price

D

S

AVC

MC

PE

QE

OMAX

Quantity


If demand increases
If Demand Increases……

The Market

The Firm

Price

D1

Price

D

S

AVC

MC

PE

QE

10 11

Quantity


If demand decreases
If Demand Decreases……

The Market

The Firm

Price

Price

D

S

D2

AVC

MC

PE

QE

9 10

Quantity


Firm is a price taker in the input market
Firm is a “Price Taker” in the Input Market

Labor Market

The Firm

Price

Price

D

S

MVP

MIC

PE

QE

LMAX

Quantity


Firm is a price taker in the input market1
Firm is a “Price Taker” in the Input Market

Labor Market

The Firm

Price

Price

D

S

MVP

PE

MIC

QE

LMAX

Quantity


Effects of increasing the minimum wage
Effects of Increasing The Minimum Wage

Labor Market

The Firm

Price

Price

D

S

MVP

PMIN

MIC

LMAX

QS

QD

Quantity


Summary
Summary

  • Market equilibrium price and quantity are given by the intersection of demand and supply

  • Producer surplus captures the profit earned in the market by producers

  • Total economic surplus is equal to producer surplus plus consumer surplus

  • A market surplus exists when the quantity supplied exceeds the quantity demanded.

  • A market shortage exists when the quantity demanded exceeds the quantity supplied.


Chapter 9 focuses on market equilibrium and product prices under conditions of imperfect competition….


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