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Demand, Supply, and Equilibrium in a Perfectly Competitive Market

Demand, Supply, and Equilibrium in a Perfectly Competitive Market. The Context: “Perfectly Competitive Markets”. A group of buyers and sellers of a particular good or service can be defined narrowly or broadly (e.g., rice vs. food) at a given point in time (e.g., day, month, year)

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Demand, Supply, and Equilibrium in a Perfectly Competitive Market

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  1. Demand, Supply, and Equilibrium in a Perfectly Competitive Market

  2. The Context: “Perfectly Competitive Markets” • A group of buyers and sellers of a particular good or service • can be defined narrowly or broadly (e.g., rice vs. food) • at a given point in time (e.g., day, month, year) • Enough buyers and sellers so that no one has an impact on the price • typical with many buyers and sellers

  3. Willingness to Pay • Willingness to pay (WTP): the maximum amount that a buyer will pay for a good • Further distinctions are helpful… • Marginal willingness to pay (MWTP): WTP for one more unit of a good • Total willingness to pay (TWTP): WTP for any number of units of a good

  4. An Individual’s WTP for good X

  5. An Individual’s Demand Curve • A graph of an individual’s MWTP curve is her demand curve • Demand curve: gives the relationship between the price of a good and the quantity demanded • Law of demand: downward sloping curve reflects diminishing MWTP

  6. An Individual’s Demand Schedule • A table that gives the relationship between the price and quantity demanded • Based on the individual’s MWTP

  7. Consider a Market with Two Individuals

  8. The Market (Aggregate) Demand Curve • A horizontal summation of individual demand curves • Tells the market quantity demanded at any given price • Also tells the MWTP in the market—the most someone is WTP for each additional unit of the good

  9. A Note on Demand Semantics • Changes in price result in “changes in the quantity demanded” • “Changes in demand” imply shifts of the demand curve

  10. Shifters of the Demand Curve • Changes in income, + (-) • Normal goods, + (-) • Inferior goods, - (+) • Changes in the price of related goods, + (-) • Substitutes, + (-) • Complements, - (+) • Tastes and preferences • Expectations • Number of buyers in the market, + (-) implies + (-)

  11. A Firm’s Marginal Cost (MC) of Production • Marginal cost (MC): tells a firm’s incremental cost of producing an additional unit of a good • We assume it is increasing (for now) • We ignore the total costs of production (for now)

  12. A Firm’s MC of Producing Good X

  13. An Firm’s Supply Curve • A graph of a firm’s MC curve is its supply curve • Supply curve: gives the relationship between the price of a good and the quantity supplied • Law of supply: upward sloping curve reflects increasing MC

  14. A Firm’s Supply Schedule • A table that gives the relationship between the price and quantity supplied • Based on the firm’s MC

  15. Consider a Market with Two Firms

  16. The Market (Aggregate) Supply Curve • A horizontal summation of the individual firm supply curves • Tells the market quantity supplied at any given price • Also tells the MC in the market—the lowest cost of producing each additional unit of the good

  17. A Note on Supply Semantics • Changes in price result in “changes in the quantity supplied” • “Changes in supply” imply shifts of the supply curve

  18. Shifters of the Supply Curve • Changes in input prices, + (-) implies - (+) • Changes in the technology of production, such that better (worse) implies + (-) • Expectations • Number of sellers in the market, + (-) implies + (-)

  19. Equilibrium: Supply “meets” Demand • The intersection of the supply and demand curves determines the equilibrium price and quantity • Market clearing condition: when the quantity supplied equals the quantity demanded • Given the equations for the supply and demand curves, you can solve algebraically for P* and Q*

  20. Equilibrium Proof by Contradiction • If P > P*, then there would be excess supply (a surplus) • Firms would lower prices • If P < P*, then there would be excess demand (a shortage) • Consumers would pay more • Must be true that P = P* and that QS = QD = Q*

  21. Comparative Static Analysis Ceteris paribus : other things being equal • An increase (decrease) in demand results in more (less) exchange at a higher (lower) price • An increase (decrease) in supply results in more (less) exchange at a lower (higher) price • Simultaneous shifts in supply and demand can generate ambiguous effects

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