Market Equilibrium and Market Demand: Perfect Competition

1. MarketEquilibrium and Market Demand:Perfect Competition Chapter 8

2. Discussion Topics • Derivation of market supply curve • Elasticity of supply and producer surplus • Market equilibrium under perfect competition • Total economic surplus • Adjustments to market equilibrium

3. Remember the firm’s supply curve? P=MR=AR Page 123

4. P=MR=AR Firm’s supply curve starts at shut down level of output Page 162

5. Profit maximizing firm will desire to produce where MC=MR P=MR=AR Page 162

6. Economic losses will occur beyond output OMAX, where MC > MR P=MR=AR Page 162

7. Building the Market Supply Curve Market supply curve can be thought of as the horizontal summation of the supply decisions of all firms in the market. Here, at a price of $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons. Page 163

8. Building the Market Supply Curve + Market supply curve can be thought of as the horizontal summation of the supply decisions of all firms in the market. Here, at a price of $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons. Page 163

9. Building the Market Supply Curve = + Market supply curve can be thought of as the horizontal summation of the supply decisions of all firms in the market. Here, at a price of $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons. Page 163

10. Merging Demand and Supply Price D S Market clearing price PE Quantity QE

11. Merging Demand and Supply Price D S PE Chapters 3-5 Quantity QE

12. Merging Demand and Supply Factors that change demand: • Other prices • Consumer income • Tastes and preferences • Real wealth effect • Global events D* Price D S PE* PE Quantity QE* QE

13. Merging Demand and Supply Price D S Chapters 6-7 PE Quantity QE

14. Merging Demand and Supply S* Factors that change supply: • Input costs • Government policy • Price expectations • Weather & disease • Global events Price D S PE* PE Quantity QE* QE

15. Concept of Producer Surplus Producer surplus is a fancy term economists use for profit. We measure producer surplus as the area above the supply curve and below the market equilibrium price. Page 165

16. Concept of Producer Surplus Producer surplus is a fancy term economists use for profit. We measure producer surplus as the area above the supply curve and below the market equilibrium price. Total economic surplus is therefore equal to consumer surplus discussed in Chapter 4 plus producer surplus. Page 165

17. Market Price of $4 A B Product price Producer surplus at $4 is equal to area ABC F G Page 165

18. Suppose Price Increased to $6… Product price Producer surplus at $6 is equal to area EDC F G Page 165

19. The gain in producer surplus if the price increases from $4 is equal to area AEDB Producers are better off economically by responding to this price increase by producing output G C F G Page 165

20. An Example of Economic Welfare Analysis Assume a drought occurs that results in a decrease in supply from S to S*. Before this happened, consumer surplus was area 3+4+5 while producer surplus was equal to area 6+7. Total economic equals area 3+4+5+6+7 Page 169

21. An Example of Economic Welfare Analysis After the decrease in supply, consumer surplus is just area 3. They lose area 4 and area 5. Producers gain area 4 but lose area 7. Page 169

22. An Example of Economic Welfare Analysis Consumers are therefore worse off because of the drought. Producers are also worse off if area 4 is less than area 7. Society loses area 5+7. Page 169

23. Measuring Surplus Levels $7 D Consumer surplus is equal to (10 x (7-4))÷2, or $15 S $4 Product price $1 10 Page 168

24. Measuring Surplus Levels $7 D Consumer surplus is equal to (10 x (7-4))÷2, or $15 S $4 Product price Producer surplus is Equal to (10 x (4-1))÷2, or $15 $1 10 Page 168

25. Measuring Surplus Levels $7 D Consumer surplus is equal to (10 x (7-4))÷2, or $15 S $4 Product price Producer surplus is Equal to (10 x (4-1))÷2, or $15 $1 10 Total economic surplus is therefore $30… Page 168

26. Modeling CommodityPrices

27. Forecasting Future Commodity Price Trends $7 D S D = a – bP + cYD + eX $4 Own price Other factors Disposable income $1 10 Page 168

28. Forecasting Future Commodity Price Trends $7 D S Own price Input costs Other factors $4 S = n + mP – rC + sZ $1 10 Page 168

29. Projecting Commodity Price $7 D S D = 10 – 6P + .3YD + 1.2X D = S $4 S = 2 + 4P – .2C + 1.02Z $1 10 Substitute the demand and supply equations into the the equilibrium condition and solve for price Page 221

30. Many Applications • Policy decisions by Congress and the president • Commodity modeling by brokers and traders • Credit repayment capacity analysis by lenders • Outlook presentations by extension economists • Planting decisions by farmers • Herd size and feedlot placement decisions by livestock producers • Strategic planning for processors

31. Market Disequilibrium

32. Market Surplus At the price is PS, producers would supply QS. Page 170

33. Market Surplus At the price is PS, consumers would only want QD. Page 170

34. Market Surplus At the price is PS, a market surplus equal QS – QD exists Page 170

35. Market Shortage At the price is PD, producers would only supply QS. Page 170

36. Market Shortage Consumers want QD at this low price. Page 170

37. Market Shortage Consumers want QD at this low price. At the price is PS, a market shortage equal QD – QS exists Page 170

38. Adjustments to Market Equilibrium Markets converge to equilibrium over time unless other events in the economy occur. One explanation for this adjustment which makes sense in agriculture is the Cobweb theory. This names stems from the spider like trail the adjustment process makes.

39. Year 2 Reactions Producers use last year’s price as their expected price for year 2. Consumers on the other hand pay this year’s price determined by Q2. Page 172

40. Year 3 Reactions P3 P2 Producers now decide to produce less at the lower expected price. This lower quantity pushes price up to P3 in year 3. Page 172

41. Cobweb Pattern Over Time Market equilibrium The market converges to market equilibrium where demand intersects supply at price PE. In some markets, this adjustment period may only be months or even weeks rather than years assumed here. Page 172

42. Market-to-Firm Linkages

43. Some Important Jargon We need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve.

44. Some Important Jargon We need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve. Movement along a curve is referred to as a “change in the quantity demanded or supplied”. A shift in a curve is referred to as a “change in demand or supply”.

45. Increase in demand pulls up price from Pe to Pe* Decrease in demand pushes price down from Pe to Pe* Page 167

46. Decrease in supply pulls up price from Pe to Pe* Increase in supply pushed price down from Pe to Pe* Page 167

47. Merging Demand and Supply Price D S Chapters 6-7 PE Chapters 3-5 QE Quantity

48. Firm is a “Price Taker” Under Perfect Competition The Market The Firm Price Price D S AVC MC PE QE OMAX Quantity

49. If Demand Increases…… The Market The Firm Price D1 Price D S AVC MC PE QE 10 11 Quantity

50. If Demand Decreases…… The Market The Firm Price Price D S D2 AVC MC PE QE 9 10 Quantity