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Consumption, Production, Welfare B: Competitive markets (partial eq )

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## Consumption, Production, Welfare B: Competitive markets (partial eq )

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**Consumption, Production, Welfare B:Competitivemarkets**(partial eq) Univ. Prof. dr. Maarten Janssen University of Vienna Winter semester 2013**Must individual supplycurvealwaysbeupwardsloping?**• Supplycurvedenotedby s(p;w) • Individual supplierstakeinputandoutputpriceasgiveniftheyaresmall relative totherespectivemarkets • Profit maximizationimpliesthat 2nd orderconditionisfulfilled: mc areincreasing. • Thus, situationhereisquite different fromsituationwhetherdemandshouldbedownwardsloping. • Whatisthedifference?**Aggregate supply**• Aggregate supplyis, in principle, thesumofthe individual supplycurves. • Aggregation isdonehorizontally • But onlyiftheassumptionofgiveninputpricesholds also atthemarketlevel (thisindustryisonlyoneofmanyusingthatinput) • Wheninputpricesare not givenatthemarketlevel, situation on right will happen • Effectivesupplycurvesmaybedownwardslopingifinputpricesincreasesufficiently Effectivesupply price y**Aggregate demand**• Individual i‘sdemandforcommodity j denotedby • Aggregate demandissumof individual demands • Depends on othermarketpricesandindividual incomessuppressed • Not unproblematic. Suppose. Youcanonlywriteaggregatedemandas a functionofif all have same valueofγ.**Market equilibrium**• Market equilibriumis a priceatwhich all consumersandsupplierscanrealizetheir optimal choice. • Doesitalwaysexist? p p S(p) p S(p) S(p) D(p) D(p) D(p) y y y**Existence**• Excess demand z(p) = D(p)-S(p) • Ifitiscontinuousfor • thereexists a such that, • andthereexists a such that, • then a competitivemarketequilibriumexist (partial equilibrium)**Stabilityofequilibrium**• Nice toknowthatequilibriumexists (undersomeconditions), but mayweexpectitto happen in the real world? • Orat least a tendency in thatdirection. • Problem isthat in thetheorynooneissupposedtohave an influence on price, so questionishow do pricesemerge? • What type ofinformationisrequiredtoreach a marketequilibrium? • Twoprocesses: tatonnement, expectationdrivendynamics**Tatonnement**• Prices adjustaccordingtoexcessdemand: , whereλ>0. • „Formalisation“ of Invisible Hand p z(p)**Cobweb (expectation) process**• Firms (farmers) form expectationsaboutmarketprice, based on previousperiods • Supply S(), demand D() • Stable, unstableprocess • Suppose demandandsupplycurves linear • Differenceequation • Stableif < 1. p S(p) D(p) y**Information requirements**• Iftheseprocesseswork, thenthegreatthingisthat individual agentsonlyneedtoknowtheprices, andthemarketsystemthenperformstherest • Information decentralisation • Still remainssomewhatof a mystery • In plannedeconomies, todeterminetheprices, oneplanningorganisationneedstoknow all costcurvesandpeople‘spreferencestocalculatethebestprices • Impossibletask**Long-run equilibrium**• So far, westudied „short-run“ equilibriumwherethenumberoffirmsisfixed. In short-run, firmscanmakeprofits. • In long-run, whenthereisprofits, newfirmsenterthemarket. • Note thisisbased on notionofopportunitycost • Note thisis a different notionof „long-run“ thanwhentalkingaboutcost. Wemaycallthis „ultralong-run“**MC**P ATC y Short-run vs Long-run dynamics p S(p) D(p) Q Market level Individual firm**Long-run equilibrium**• Long-run supplycurveis horizontal atlevelofminimumofaverage total costcurve. • Ifpricewouldbehigher, there will beentry in theindustry • Ifpriceislower, there will beexit p D(p) S(p) Q**Whataboutwelfare?**• Consumer surplus: Willingnesstopay – whathastobepaid (bluearea) • Producer surplus: revenue – cost (greenarea) • Total Surplus: sumofthetwo (whenthereisnogovernment) p S(p) D(p) Partial equilibrium outcome is Pareto-efficicientas there does not exist another possible outcome such that no decision maker is worse off and at least one is strictly better off. y**Other possiblearrangements**• Price floorabovecompetitiveprice (redline) • Whytointroduceit? • Protectsuppliers? (thinkofminimum wage and potential employees) • Whathappensto total surplus? Are suppliersbetter off? p S(p) D(p) Similaranalysisforpriceceilings (forexample, appartmentrentceilings). Who benefits? Interventionsusuallycreatetheirowninterestgroupsandthenlaterdifficulttochange y**Whenis Consumer Surplus appropriatemeasure?**• Consumer surplusisareaunderwalrasiandemand • EarlierwesaidappropriatemeasureisareaunderHicksiandemand (EV or CV, depending on whichpriceistakenasreferencepoint). • CS in between, but exactlyrightifthereisnoincomeeffect • U(x) + m p p’ x(p,w) h(p,u’) h(p,u) X**Non-equilibrium priceand Pareto efficiency**• Atequilibriumquantity marginal costofproducing extra unit, equalto marginal willingnesstopay. • At larger quantity, marginal costofproducing extra unit larger than marginal willingnesstopay • Better not toproducethat extra unit • At larger quantity, marginal costofproducing extra unitsmallerthanmarginal willingnesstopay • Bettertoproducethat extra unit