Markets and Competitive Equilibrium

1. Markets and Competitive Equilibrium Lecture 5

2. In This Lecture • Market Equilibrium and the Forces Moving the Market Toward Equilibrium • The Hypothesis of a Single Price • Changes in Demand and Supply • Case Study--Gasoline Prices • Case Study--Scalping ND Football Tickets

3. Demand Given a price, how much will be demanded? Given a quantity, what is the maximum amount would the demanders be willing to pay? Supply Given a price, how much will be supplied? Given a quantity supplied, what is the minimum price per unit would be acceptable to the suppliers? Is PH an Equilibrium Price? Price S D Donuts Demand and Supply Review PH QD QS

4. At the price, PH, there is more of the good being supplied than demanded Consequently, these suppliers who can’t sell at PH will offer their output at a slightly lower price -- have a sale. The sale will take away purchases from competitors who will be forced to lower their prices to maintain sales Price will fall! Price S PH D QD QS Donuts Too High of a Price Results in Excess Supply

5. At the price, PL, there is more of the good being demanded than supplied Consequently, supplies will sell out and still have customers wanting to buy product at PL. Price will rise! Price S D QS QD Donuts Too Low of a Price Results in Excess Demand PL

6. At PE, the quantity demanded is equal to the quantity supplied At this price, everyone’s wishes are being met -- no one has incentive or desire to do something different If nothing else changed, we would expect the price and amount of donuts produced and sold to be constant over time Price S D Donuts Equilibrium Price PE QE=QS=QD

7. Social Function of Prices • Prices coordinate decisions between sellers and buyers • Will everyone be on the same page?

8. Single Price In a significant number of situations, individuals are charged different amounts for the same good (car purchases). Yet we would expect there to be a single price in a competitive market. Why? IF everyone knew the rate (price) that others were trading, why would they every pay more than others were paying? Why would sellers accept less? If they did then the multiple prices could not be an equilibrium since they would want to do something else. We are assuming perfect information on the part of buyers and sellers of the goods.

9. Alternatives to Price Rationing • Prices ration scarce goods to those who are willing and able to pay. • What other rationing mechanisms are there? • Can these alternatives produce outcomes equal in efficiency?

10. Price So Po D1 Do Qo Donuts Increase in Demand • Increase in Demand • At existing price, Po, there is excess demand -- customers want more of the good • Both price and the quantity supplied rise, a movement along the supply curve • New Equilibrium • Higher equilibrium price • Higher equilibrium quantity P1 Q1

11. Price So Po Do D1 Qo Donuts Decrease in Demand • Decrease in Demand • At existing price, Po, there is excess supply -- there are goods on the shelf -- sale! • Both price and the quantity supplied fall, a movement along the supply curve • New Equilibrium • Lower equilibrium price • Lower equilibrium quantity P1 Q1

12. Price S1 So Po Do Qo Donuts Decrease in Supply • Decrease in Supply • At existing price, Po, there is excess demand -- customers want more • Price rises and quantity demanded falls, movement along the demand curve • New Equilibrium • Higher equilibrium price • Lower equilibrium quantity P1 Q1

13. Price So S1 Po Do Qo Donuts Increase in Supply • Increase in Supply • At existing price, Po, there is excess supply -- inventories rise -- sales • Price falls and quantity demanded increases, movement along the demand curve • New Equilibrium • Lower equilibrium price • Higher equilibrium quantity P1 Q1

14. Nominal Gasoline Prices

15. Real Gasoline Prices

16. Why has the price of gas risen? • Increase in the price of crude oil (supply consideration) • Decrease in oil reserves? • Instability in oil producing regions • No increase in the refinery capacity (supply considerations) • Increase in the demand for gasoline • Economic Growth in China and other developing nations • Our own growth

17. Monthly Gas Prices (1992-1996)

18. Explaining Monthly Changes • Summer Vacations -- Drive More (Demand Shift) • In May, refineries shut down for maintenance and shift over to seasonal blends (Supply Shift)

19. SM SS Price SW PS PW DW Gallons Seasonal Changes DS

20. Variation in Gas Prices over the Week • Why does the price of gas rise during the weekend? a. Demand considerations • Supply considerations • Are the increases justified? That is, are they fair to the consumer?

21. ND Football Ticket Policy • What is ND’s pricing strategy? • Tickets sales account for ~90% of athletic budget • Opposed to filling the stadium with season ticket holders; unfair to alums who live far away • 4,000 season ticket holders account for ~15,000 seats • Uses a lottery to fill remaining seats • Refundable Application fee per game: • 5 yrs < $50 < 50 yrs • $100 all other graduating classes • Application fees are sent to Development Office

22. ND Football Ticket Policy • What are the determinants of ND’s printed ticket prices? • Explicit philosophy: Do NOT let ticket prices reach market price • Uniform price regardless of location • What is ND’s resale policy? • Resale above the printed ticket price is illegal and subject to penalty • Resale is “unethical.” The football game is “our product.” Others should not profit.

23. The Secondary Market for ND Football Tickets • Why is ticket scalping inevitable? • Hint: Why are ticket available for resale? Who are the sellers • Who are the buyers in the secondary market? • Is the secondary market competitive? • Does the secondary market improve the allocative efficiency of the market for ND football tickets?

24. Notre Dame Ticket Scalping • What we learned from interviews with scalpers • Scalpers are both buy and sell • Their strategy is to buy low and sell high • There are two categories of scalpers • Corporate brokers (PJ Tickets, Victory Tickets) • Amateurs (High school buddies) • Corporate brokers buy from ticket holders hoping to make a profit • Amateurs buy from ticket holders hoping to get their money back.

25. Notre Dame Ticket Scalping Amateurs: • Their profit margin goal is $15 per sale • Take turns like car dealers. The lowest price is quoted by the up guy. • The reduce risk, they hold no more than 10 tickets at a time • Each amateur sells 50 to 100 tickets a game and pocket $750 TO $1,500 in profits. • Guesstimate of the number of tickets scalped per game: ~3,000

26. Assignment for Next Lecture • Do Homework 4 on ‘Homework Assignment’ by Wednesday at 5 pm • Read Chapter 4 • Topics Next Time • The Market Strikes Back (It’s difficult to control the market)