Introductory Economics- Lecture 7 notes PDF

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Introductory Economics- Lecture 7 notes summary...

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SUPPLY AND DEMAND: PRICE-TAKING AND COMPETITIVE MARKETS • • • •

Competition can constrain buyers and sellers to be price-takers Price-taking ensures that all gains from trade in the market are exhausted at a competitive equilibrium The model of perfect competition describes idealised conditions under which all buyers and sellers are price-takers Prices provide a measure of scarcity. If the price rises, consumer may switch to alternative, thereby saving resources.

BUYING AND SELLING: DEMAND AND SUPPLY • Unit 7 we considered a monopoly. We now look at competitive markets. When there are many firms producing the same product, each firm’s decisions are affected by the behaviour of competing firms, as well as consumers. Demand • E.g. demand for textbook comes from students who differ in their willingness to pay. No one will pay more than the price of a copy in the bookshop. Student’s WTP depends on how hard they work, how important they think the book is etc • We line up all consumers in order of willingness to pay, with the highest first. e.g. first student is willing to pay $20, the 20th $10 • Demand curve represents WTP- tells you how many students would be willing to buy: it is the number whose WTP is at or above P. Supply • Supply depends on sellers’ willingness to accept (WTA) which is the reservation price of a potential seller, who is willing to sell a unit only for a price at least this high • The supply curve is the firm’s MC curve from the point where we make normal profit • Supply of second-hand books comes from students who have completed course, who differ in the amount they are willing to accept- reservation price.That is the least price at which someone is willing to sell a good (keeping the good is the potential seller's reservation option).Poorer students and those no longer studying economics may have lower reservation prices • We can draw a supply curve by lining up the sellers in order of their reservation prices(WTA) those who have the lowest reservation prices go first • E.g first seller has a reservation price of $2 and will sell at any price above that

THE MARKET AND THE EQUILIBRIUM PRICE • Modern communications: sellers can advertise and buyers can easily find out what is available, and where. But in some cases, still convenient to meet together • End of the 19th century, Alfred Marshall introduced model of S&D • Most English towns had Corn Exchange. Marshall said supply curve of grain determined by prices that farmers willing to accept, and demand curve by willingness to pay of merchants. • Marshall called the price that equated supply and demand the equilibrium price.- is self perpetuating, no reason to change unless change in market conditions • Marshall’s argument based on assumption that grain same quality. His model can be applied to markets in which all sellers are selling identical goods, so buyers are equally willing to buy from any seller. • Market for the textbook, we assume that all the books are the same • Market clearing( no excess demand or supply) price is $8

Price Taking • Participants are price takers as they cannot benefit by choosing a different price from the equilibrium .Have to accept the price in the market. Contrast to sellers of differentiated products who are price makers but buyers are price takers. • Price taking occurs when many sellers are selling identical goods, and many buyers wishing to purchase them. • Sellers forced to be price-takers by the presence of other sellers, and by buyers who choose seller with lowest price. • If seller set a higher price, buyers would go elsewhere. • Buyers are price-takers when there are plenty of other buyers, and sellers willing to sell to whoever will pay the highest price. On both sides of the market, competition eliminates bargaining power. • We say equilibrium is a competitive equilibrium as all buyers and sellers are price-takers, and at the prevailing market price, quantity supplied equals quantity demanded. • A competitive market equilibrium is a Nash equilibrium because given what all other actors are doing (trading at the equilibrium price) no actor can do better than to continue what he or she is doing (also trading at the equilibrium price).

PRICE-TAKING FIRMS • We look at markets where the sellers are firms not individuals • If there were many firms producing identical products, and consumers could easily switch from one firm to another, then firms will be price-takers in equilibrium. Unable to benefit by to trade at price different to equilibrium • As output rises, average cost falls, but marginal costs begin to rise gradually because you have to employ extra staff and use equipment more intensively. At higher quantities the MC is above the AC so AC rises. • If P=AC then economic profit is 0- so the AC curve is the zero-economic-profit curve • We plot isoprofit curves which slope down where P is above MC, and up where P is below MC, so the MC curve passes through the lowest point on each isoprofit curve. If P>MC , total profits can remain unchanged only if a larger quantity is sold for a lower price. e.g. bread maker. MC curve passes through lowest point of AC and plot isoprofits. Bakery is price taker so price is €2.35 The demand curve is flat for a price- taker For bakery, the price charged by competitors affects its demand curve. We call it the firm’s demand curve as if charges more than P* your demand will be zero; at P* or less you can sell as many loaves as you like. • Price takers always produce where P*=MC • D=S so f’(Q) = C’(Q)-P /Q. Slope of demand is 0. We can rearrange this to get P=C’(Q) i.e. P=MC

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Profit is max at A Demand curve is always horizontal so max profit occurs where isoprofit is horizontal. where isoprofit curves are horizontal, P*=MC If P*0 thus G”(Q)-C”(Q)+F...