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

Consumption, Production, Welfare B: Competitive markets (partial eq ). Univ. Prof. dr. Maarten Janssen University of Vienna Winter semester 2013. Must individual supply curve always be upward sloping ?. Supply curve denoted by s( p; w )

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

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  1. Consumption, Production, Welfare B:Competitivemarkets (partial eq) Univ. Prof. dr. Maarten Janssen University of Vienna Winter semester 2013

  2. Must individual supplycurvealwaysbeupwardsloping? • Supplycurvedenotedby s(p;w) • Individual supplierstakeinputandoutputpriceasgiveniftheyaresmall relative totherespectivemarkets • Profit maximizationimpliesthat 2nd orderconditionisfulfilled: mc areincreasing. • Thus, situationhereisquite different fromsituationwhetherdemandshouldbedownwardsloping. • Whatisthedifference?

  3. 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

  4. 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.

  5. 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

  6. Existence • Excess demand z(p) = D(p)-S(p) • Ifitiscontinuousfor • thereexists a such that, • andthereexists a such that, • then a competitivemarketequilibriumexist (partial equilibrium)

  7. 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

  8. Tatonnement • Prices adjustaccordingtoexcessdemand: , whereλ>0. • „Formalisation“ of Invisible Hand p z(p)

  9. 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

  10. Information requirements • Iftheseprocesseswork, thenthegreatthingisthat individual agentsonlyneedtoknowtheprices, andthemarketsystemthenperformstherest • Information decentralisation • Still remainssomewhatof a mystery • In plannedeconomies, todeterminetheprices, oneplanningorganisationneedstoknow all costcurvesandpeople‘spreferencestocalculatethebestprices • Impossibletask

  11. 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“

  12. MC P ATC y Short-run vs Long-run dynamics p S(p) D(p) Q Market level Individual firm

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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

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