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Market Outcomes

Market Outcomes. Executive MBA 512 Session #11 Presented by Brian Greber November 15, 2012. 5- 1. Cleaning Up Supply from Last Class. 5-29. Market vs Individual Supply?. In contrast to individual consumers, it is often important to understand the economic supplies of individual firms:

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Market Outcomes

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  1. Market Outcomes • Executive MBA 512 • Session #11 • Presented by • Brian Greber • November 15, 2012 5-1

  2. Cleaning Up Supply from Last Class 5-29

  3. Market vs Individual Supply? • In contrast to individual consumers, it is often important to understand the economic supplies of individual firms: • Your firm • Concentrated Industries • From a price and market perspective the focus becomes “market supply” • the collective supply of all firms. • We infer this from historic price/production behavior 5-29

  4. What causes supply to shift? • Number of sellers • Anything that shifts marginal costs: • Resource prices • Technology • Taxes and subsidies • Prices of other goods (opportunity costs) • Producer expectations 5-4

  5. Shape/slope of supply • Note, the shape is measuring the responsiveness of cost to changes in quantity supplied • Inversely, the shape reflects the responsiveness of quantity supplied to changes in price • What economists call “price elasticity” of demand Percentage Change in Quantity Supplied of Product X EsX= Percentage Change in Price of Product X 5-5

  6. Price Elasticity of Supply Examples? Extreme cases • Perfectly inelastic supply • Perfectly elastic supply • Unitary Elasticity S p p p S S Q Q Q 5-6

  7. What influences slope of supply • Shape of curve for inputs • Diminishing returns • Time • Market period • Perfectly inelastic supply • Short run • Fixed plant size • Long run • Adjustable plant size • Supply more elastic • More elastic in the long run 5-7

  8. January 2012 Article on End of Elastic Oil • How did they characterize the overall elasticity of supply for oil? • How did they say it differed between the OPEC countries and the US? Why • Is the elasticity of oil greater in the long run or the short run? Why? • Did the article contend that the short-run elasticty of supply is getting “more or less” elastic through time? Why? • Dies this contradict the preceding point? • Diminishing returns • Time • Market period • Perfectly inelastic supply • Short run • Fixed plant size • Long run • Adjustable plant size • Supply more elastic • More elastic in the long run 5-8

  9. Cross Price elasticity of supply • Elasticity > 0, production complements ….. Examples? • Elasticity < 0, production competitors …. Examples? Percentage Change in Quantity Supplied of Product X EsXY= Percentage Change in Price of Product Y 5-9

  10. Law of Diminishing Returns • Fixed technology • Add variable resource to fixed resource • Marginal product will decline • Beyond some point • The faster the rate of decline, the steeper the marginal cost/supply curve They Need a Heavier Donkey... 5-10

  11. (3) Marginal Product (MP), Change in (2)/ Change in (1) (3) Average Product (AP), (2)/(1) (1) Units of the Variable Resource (Labor) (2) Total Product (TP) ] ] ] ] ] ] ] ] Law of Diminishing Returns - 10.00 12.50 15.00 15.00 14.00 12.50 10.71 8.75 0 10 25 45 60 70 75 75 70 0 1 2 3 4 5 6 7 8 10 15 20 15 10 5 0 -5 Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 5-11

  12. Law of Diminishing Returns 30 Total Product, TP 20 10 0 20 Marginal Product, MP 10 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 TP Increasing Marginal Returns Negative Marginal Returns Diminishing Marginal Returns AP 5-12 MP

  13. Average Product and Marginal Product Cost (Dollars) Graphical Relationships Production Curves AP MP Quantity of Labor MC AVC Cost Curves Quantity of Output 5-13

  14. Costs and decisions • Average fixed cost • Understand effect of scale on “leveraging” costs • Average variable cost • Key controllable cost on a day-to-day basis; key to shut down economics • Produce as long as P > AVC • Average total cost • Standard for “cost accounting” • Marginal cost = Supply • Key to determining profit maximizing output levels • Competitive firm Produce to where P=MC 5-14

  15. Key take away: Supply • Supply reflects the marginal cost of production • Any market or policy changes that influence marginal costs will shift supply. 5-15

  16. July 2012 Article on Ethanol and Corn & October Article on Yeast • If requirements for ethanol use stay the same and the price of gasoline rises, what is apt to happen to the supply of corn for food purposes ? What does that say about the cross price elasticity of supply? • What would happen to food prices related to corn as a feed, grain, or vegetable? • If the demand and price of corn for ethanol falls, what would happen to the demand for yeast? • What does that say about the cross price elasticity of demand for yeast? • So what does that mean that an increase in oil prices will eventually do to yeast prices? • Now you are thinking like an economist……. 5-16

  17. Today’s New Objectives • Review the neo-classical “competitive” market and discuss exceptions. These will include non-competitive markets, imperfect information, and externalities. • Enable a structured approach to thinking through trends, cycles, and fluctuations in market prices and quantities. • Provide basic framework for thinking through the “conduct” of consumers, suppliers, and producers (competitors). • Place these concepts into a strategic planning framework and understand their implications for government policy. 5-17

  18. Pure Competition ? 5-18

  19. Assumptions for efficient market • Private property • Yields investment, innovation, exchange, maintenance, & growth. • Freedom of enterprise and choice • Scalability, Entry and exit • Self-interest • Creates “checks and balances” • Costs and benefits understood, and internalized • Information • Lack of “side effects” • Fair Competition among players • Many players on “both sides of the market” • No lying, cheating, stealing, colluding, …. • Markets and prices allowed to function ans supported with viable currency 5-19

  20. Market Equilibrium ….. • The meeting of the minds that balances price and quantity • Avoids surplus and shortage • Uses price for Rationing • Leads to Efficient allocation • Productive efficiency • Allocative efficiency among consumers and producers 5-20

  21. Putting D&S together 5-21

  22. Competitive Equilibrium is Good! Consumer Surplus Equilibrium Price = $8 P1 Price (Per Bag) D Q1 Quantity (Bags) 5-22 5-22

  23. Competitive Equilibrium is Good! S Producer Surplus Equilibrium Price = $8 P1 Price (Per Bag) Q1 Quantity (Bags) 5-23

  24. Competitive Equilibrium is Good! S Consumer Surplus Equilibrium Price = $8 P1 Price (Per Bag) Producer Surplus D Q1 Quantity (Bags) 5-24

  25. Putting D&S together What happens if you instill quotas, price ceilings, or floors? 5-25

  26. Truth is ….. The market is rarely at a competitive equilibrium! 5-29

  27. Market Cycles: Imperfect Information Causes “Oscillations” in Prices, Outputs, and Inventories • How do I know what price to charge? • What happens if I charge too much? • What happens if I charge too little? • What actually happens in the market is sometimes called “the cobweb effect” 5-27

  28. Market Cycles: Imperfect Information Causes “Oscillations” in Prices, Outputs, and Inventories Inventory Price/ Production Q New York Times Article on Inventories Time 5-28

  29. Market Trends: Inertia/Momentum causes supply/demand to continually shift through time • Population • Productivity • Scarcity (?) • Other ???? 5-29

  30. Market Equilibrium: Use Board Quantity Price Supply shift out; Demand decrease Supply shift in; Demand increase Supply shift out; Demand increase Supply shift in ; Demand decrease ? ? ? ? 5-30 5-30

  31. Market Shocks: One time events, start the cobweb, again! Inventory Price/ Production Q Time 5-31

  32. Trend and Cycle Price or Quant Trend Trend & Cycle Time

  33. Full disclosure and “internalization” of all costs/benefits is critical to efficient markets ….. 5-29

  34. P P 0 Q Q Asymmetric Information: Bad thing! Hidden costs St St Mis-represented benefits S Dt D D Overallocation Overerallocation 0 Qo Qe Qo Qe See: Law school debt, Reebok articles Consider: What happens when consumer lies on insurance forms Information witheld by buyer or seller is inefficient. 5-34

  35. Externalities 9-35

  36. Inefficient Equilibrium: Externalities 5-36

  37. P P 0 Q Q Inefficient Equilibrium: Externalities Negative Externalities St St Positive Externalities S Dt D D Overallocation Underallocation 0 Qo Qe Qe Qo Negative Externalities Positive Externalities 5-37

  38. Number of players influences market outcomes….. 5-29

  39. What limits competition?: Barriers to Entry • Economies of scale • Legal barriers to entry • Patents • Licenses • Ownership or control of essential resources • Capital intensity • Pricing and other strategic barriers to entry 5-39

  40. Market Structure (Models) Market Structure Continuum & exit Demand to firm Perfecty elastic – Price taker Nearly Perfecty elastic – Price taker Typically “kinked” Downward sloping = market D 7-40

  41. Monopoly Fundamentals • Single firm faces entire demand schedule. • Firm’s output decision drives market rice (conversely price decision drives market quantity). • MR curve is below price curve, because price change effects all prior units of production. • Monopoly will produce where MR=MC; • Outcome (assuming no cost advantage): • Lower Quantity • Higher Price • Disproportionate allocation of market value to producer profits • Inefficiency compounded when monopolist price discriminates 5-41

  42. Monopoly Fundamentals Pure Monopoly Purely Competitive Market S=MC MC b Pm P=MC= Minimum ATC c Pc Pc a D D MR Qc Qm Qc Pure competition is efficient Monopoly is inefficient 7-42 5-42

  43. Monopoly Fundamentals 5-43

  44. Oligopoly & Monopolistic Competition 5-44

  45. Monopolistic Competition • Fairly large number of suppliers • Easy entry and exit • Segmentable markets • Differentiation allows for non-price competition • Enables firm’s some capability to manage pricing. • Potentially inefficient, depending upon pricing control • Which industries? 5-45

  46. Oligopoly • A few large producers – enabled by entry barriers • Four-firm concentration ratio • Needs to be more than 40% • Half of U.S. manufacturing • Homogeneous or differentiated products • Collusion is mutually beneficial • Enhances profit • Incentive to cheat • Sans collusion – the “kinked demand curve” • Raise price, others don’t follow, big loss in share • Lower price, others follow to preserve share 5-46

  47. Price and Costs 0 Quantity Oligopoly: Kinked Demand Can be complicated – simple version … Rivals Ignore Price Increase D2 e P0 Rivals Match Price Decrease D1 Q0 MR1 7-47 5-47

  48. Oligopoly: Price Outcomes • Wait for the “first to move” then follow • Less frequent price changes than competitive markets Competitive Market Oligopoly Market Price Price Time Time 5-48

  49. Pricing Examples Pulp – a relatively concentrated industry Lumber – a highly competitive industry

  50. Oligopoly: Issues/Options • Not productively efficient • Not allocatively efficient • Tendency to share the monopoly profit • Considerations • Increased foreign competition • Technological advance • Policies • Use antitrust laws • Divide the firm • Natural monopoly • Regulate price • Ignore • Unstable in long run

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