Week 11 Price taking and competitive markets PDF

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Week 11: Supply and Demand. Price-Taking and Competitive MarketsCotton: US civil war (1861): export of US cotton to England fell by 75%. - Large excess demand for cotton in England - Cotton prices in England increased six-fold - Consumption of cotton by factories was cut by 50% - Thousands of worker...

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Monday 2nd December 2019

Week 11: Supply and Demand. Price-Taking and Competitive Markets Cotton: US civil war (1861): export of US cotton to England fell by 75%. - Large excess demand for cotton in England - Cotton prices in England increased six-fold - Consumption of cotton by factories was cut by 50% - Thousands of workers in cotton mills out of work - Mill owners substituted Indian cotton for US cotton - Rising demand for Indian cotton raised the cotton price in India - Indian farmers switched to cotton, raising its supply. Similar trends seen in Brazil and Egypt - Indian cotton different from the US cotton  new machines to process it in high demand - Prices are powerful signals for consumers, firms and technology General model of demand: Dx = f(px, E{pxt+1}, ps, pc, Y ≥, …) to create downward sloping demand curve. Behind every demand curve stands a consumer’s willingness to pay. General model of supply: Sx = f(px, E{pxt+1}, pi, T, πalt, …) to create upward sloping supply curve. Behind ever supply curve stands a firm’s MC cost curve.

At prices above P* (8) the quantity demanded is less than quantity supplied. Therefore, there is excess supply (surplus). At prices below P* (8) the quantity demanded is greater than quantity supplied. Therefore, there is excess demand (shortage). Equilibrium in a market for good X is: Price Px* and Quantity Qx*, such that simultaneously: 1. Consumers maximise utility 2. Firms maximise profits 3. Markets clear Equilibrium is self-perpetuating, unless a change is introduced. A competitive equilibrium is an equilibrium in which all buyers and sellers are price-takers. To be a price taker, a firm needs to be: - Small, relative to the size of the market - Sell an identical (homogenous) product to the rest of the market

Monday 2nd December 2019

π is at its max when P* = MC

Monday 2nd December 2019

With relatively inelastic demand, CS > PS With relatively inelastic supply, CS < PS Distributional bottom-line = the distribution of the total surplus between consumer and producers depends on the relative elasticities of demand and supply If the Marginal product of labour increases (become more productive) the Marginal costs of the firm will fall. This means the supply shift will fall and shift to the left, causing excess supply to occur at the original equilibrium price. Subsequently, equilibrium price will fall and quantity will rise. Other factors that affect equilibrium prices and quantities are government policies, such as price regulations, free provision of goods and taxation.

Taxes - Ad-valorem taxes: each unit produced is taxed with a certain share of its value (an addition to its value) - Lump-sum (specific) taxes: each unit produced is taxed with a certain flat sum

Monday 2nd December 2019

Summary 1. The interaction of supply and demand determines a market equilibrium in which both buyers and sellers are price-takers, called a competitive equilibrium 2. Prices and quantities in competitive equilibrium change in response to supply and demand shocks 3. Price-taking behaviour ensures that all gains from trade in the market are exhausted (there is no DWL) 4. The model of perfect competition describes idealized conditions under which all buyers and sellers are price-takers 5. Real-world markets are typically not perfectly competitive 6. Many policy problems can be analysed using the demand and supply model...