Transcript Chapter 8 Powerpoint - Agricultural & Applied Economics

Market
Equilibrium and
Market Demand:
Perfect Competition
Chapter 8
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
2
Remember the firm’s
supply curve?
P=MR=AR
3
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Profit maximizing firm will desire
to produce where MC=MR
P3=MR3=AR3
P2=MR2=AR2
P1=MR1=AR1
Firm’s supply curve starts
at shut down output level
 Where MR < AVC
4
Economic losses occur
where MC > MR
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Building the Industry Supply Curve
Market supply curve:
The
horizontal summation of the
supply decisions of all firms
in the market
 At a price of $1.50, Gary would
supply 2 tons of broccoli
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Building the Industry Supply Curve
Market supply curve:
The
horizontal summation of the
supply decisions of all firms
in the market
 At a price of $1.50, Ima would
supply 1 ton of broccoli
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Building the Industry Supply Curve
Market supply curve:
The horizontal summation
of the supply decisions of all firms in the market
At a price of $1.50 market supply would be 3 tons
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Determining Market Equilibrium
With the above we have identified the
Market Supply Curve
Previously we derived the Market Demand
Curve
Horizontal summation of individual demand
curves
We can combine these concepts to identify
what is referred to as the Market
Equilibrium
8
Determining Market Equilibrium
Price
D
S
PE
Market clearing price
QE
9
Market Supply Curve =
Horizontal summation of
individual firm supply
curves
Quantity
Market Demand Curve =
Horizontal summation of
individual consumer
demand curves
Determining Market Equilibrium
Price
D
S
PE
Chapters 3 - 5
QE
10
Quantity
Determining Market Equilibrium
Factors that change
(shift) demand:
Price
D*
D
S
PE*
PE
QE QE*
11
Prices of other goods
Consumer income
Tastes and preferences
Real wealth effect
Global events
Quantity
Determining Market Equilibrium
Price
D
S
Chapters 6 - 7
PE
QE
12
Quantity
Determining Market Equilibrium
Factors that change
S*
Price
D
S
PE*
PE
QE*QE
13
(shift) supply:
Input costs
Government policy
Price expectations
Weather & disease
Global events
Quantity
Concept of Producer Surplus
Producer Surplus (PS) is a term
economists use for aggregate returns
over total variable costs
PS measured as the area above the
supply curve and below market
equilibrium price
 Remember the supply curve is
determined by individual MC
curves
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Concept of Producer Surplus
Market Price of $4
Price
Market Supply
Total Revenue = 0ABD
$4
A
B
Product Price
Total Variable Cost = 0CBD
C
0
15
D
Output
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Concept of Producer Surplus
Market Price of $4
Price
Market Supply
$4 A
B
PS at $4 =
area ABC
C
D
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Product Price
Output
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Concept of Producer Surplus
Suppose Price Increased to $6…
Price
F
$6 E
$4
A
B
PS at $6 =
area EFC
C
D
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Market Supply
G
Output
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Concept of Producer Surplus
Price
The gain in PS if the price increases
from $4 to $6 is equal to area AEFB
F
$6 E
$4
Market Supply
Producers are
better off by
increasing output
from D to G
A
B
C
D
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G
Output
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Assessing Economic Welfare
We can use the concepts of market
demand and supply to
Assess the effects of events in the
economy on the economic well being of
consumers and producers
 For a particular market
 During a specific time period
We do this using the concept of total
economic surplus (TES) defined as:
TES = CS + PS
Total Surplus
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Consumer Surplus
Producer Surplus
$
E
Assessing Economic Welfare
An Example of Economic Welfare Analysis
S
Assume we have a market
B
C
 PS = area BCE
 CS = area BCA
 TES = area BCA + area BCE
= area AEC
Then a drought occurs
A
 How can we examine whether
consumers or producers are
impacted
D
20
Q
Page 136-137
$
Assessing Economic Welfare
An Example of Economic Welfare Analysis
E
S*
S
I
F
B
H
A
G
C
Assume the drought causes
supply curve to shift up
After the drought
PS = area HFI
 Gain BFIC + Lose AHGC
CS = area FEI
 Lose BFIG + Lose GIC
 TES = area HEI
 Lose AHGC + Lose GIC
D
21
Q
Page 136-137
$
Assessing Economic Welfare
An Example of Economic Welfare Analysis
E
S*
S
Drought causes
I
F
B
H
A
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G
C
 Consumers to be worse off
as no gain area
 Producers are worse off if
area BFIG (gain) is less than
AHGC (loss)
 Area BFIG is transferred
from consumers to
producers
 Society is on net worse off as
D no gain area (area AHIC)
Q
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Assessing Economic Welfare
Measuring Surplus Levels
$
$6
B
C
ABCD = ?
FADE = ?
Supply
CS = (10 x (6-4))÷2 = $10
$4
A
D
Product price
PS =(10 x (4-1))÷2 = $15
$1
Demand
E
F
10
Q
→Total economic surplus = CS + PS
= $10 + $15 = $25
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Modeling
Commodity
Prices
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Modeling Commodity Prices
Forecasting Future Commodity Price Trends
D = α – βP + γYD + δX
$
S
$6
Own
price
Disposable
income
Other
factors
$4
Own
price
Other
factors
D
$1
10
25
Input
costs
Q
S = θ + πP – τC + χZ
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$
Modeling Commodity Prices
S
P*
QD = 10 – 6P + .3YD + 1.2X
QD = QS= Q
Q* =Q
D
S
D
Equilibrium
Condition
QS = 2 + 4P – .2C + 1.02Z
Q
Q*
How can we determine the values of P* and Q*?
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$
Modeling Commodity Prices
S
QD = 10 – 6P + .3YD + 1.2X
QD = QS= Q
Q* =Q
D
S
P*
D
Q*
Equilibrium
Condition
QS = 2 + 4P – .2C + 1.02Z
Q
 The above shows relationship between P and
either QS and/or QD
 Lets undertake a ceteris paribus analysis
and assume values for YD, X C and Z
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Modeling Commodity Prices
$
S
P*
QD = 50 – 6P
QD = QS= Q
Q* =Q
D
S
D
Equilibrium
Condition
QS = 42 + 4P
Q
Q*
 How can we determine the value of Q*
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(1) Substitute demand and supply equations into
equilibrium condition
(2) Solve for equilibrium price (P*)
(3) Substitute this price into either supply or
demand equation for Q*
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Modeling Commodity Prices
 How can we determine the value of Q* and P*
1) Substitute demand and supply equations
into equilibrium condition
Q* =QD = QS→ (50 – 6P) = (42 + 4P)
2) Solve for equilibrium price (P*)
50 – 6P = 42 + 4P → 8 + 10P = 0
→P* = 8/10 = 0.80
3) Substitute this price into either supply or
demand equation for Q*
Demand Equation
QD* = 50 – 6P* = 50 – 6(0.8) = 50 – 4.8 = 45.2
Supply Equation
QS* = 42 + 4P* = 42 + 4(0.8) = 42 + 3.2 = 45.2
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Many Applications
Policy decisions by Congress and the
President
Commodity modeling by brokers/traders
Lender credit repayment capacity
analysis
Outlook presentations by extension eco.
Farm planting decisions
Livestock producers herd size and feedlot
placement decisions
Strategic planning for processors
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Market Disequilibrium
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Market Disequilibrium
At PS→ Market Surplus exists as QS – QD > 0
Surplus
S
PS
At price PS,
consumers would
demand QD
At price PS,
producers would
supply QS
P*
PD
D
QD
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Q*
QS
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Market Disequilibrium
At PD→ Market Shortage exists as QS – QD < 0
S
PS
At price PD,
producers would
supply QD
At price PD,
consumers would
demand QS
P*
PD
D
QD
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Q*
Shortage
QS
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Market Disequilibrium
Markets converge to equilibrium over
time unless other events in the economy
occur
 One explanation for this adjustment which
makes sense for agriculture is the Cobweb
theory
 This names comes from the spider weblike trail the adjustment process makes
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Market Disequilibrium
Lets use the example of a grain producer
Producers tend to use last year’s price
(P1) as their expected price for this year
(year 2)
In contrast, consumer’s pay this years
price (P2) determined by market
equilibrium Q2
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Market Disequilibrium
Year Two Reactions
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Market Disequilibrium
Year Three Reactions
P3
P2
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Market Disequilibrium
Year Four Reactions
Producer decision
based on Year 3 Price
P3
P4
Consumer decision
based on Year 4 Price
Q4
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Market Disequilibrium
From the above results we have the
following:
(P1 – P2) > (P3 – P2) > (P3 – P4)
Price changes are getting smaller
(Q2 – Q1) > (Q2 – Q3) > (Q4 – Q3)
Quantity changes are getting smaller
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Eventually wil converge to P*, Q* the
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equilibrium price and quantity
Market Disequilibrium
Cobweb Pattern Over Time
The market converges to
an equilibrium price and
quantity
 QD = QS at PE
In some markets,
adjustment period may
months, weeks or years
 Depends on production
time required
Market
equilibrium
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Market-to-Firm Linkages
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Some Important Jargon
As we noted before we distinguish
between
 Movement along a particular demand
or supply curve
 Referred to as a change in quantity
demanded or supplied
 Shifts in the demand or supply curve
 Referred to as a change in demand
or supply
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Increase in demand
increases price from Pe
to Pe*
Decrease in demand
decreases price from Pe
to Pe*
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Increase in supply
decreases price from
Pe to Pe*
Decrease in supply
increases price from
Pe to Pe*
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Merging Demand and Supply
Price
D
S
Chapters 6-7
PE
Chapters 3-5
QE
45
Quantity
Firm is a Price Taker Under
Perfect Competition
Price
The Firm
The Market
D
S
Price
PE= MR = MC
AVC
MC
PE
QE
QF
Quantity
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Impact of an Increase in Demand
The Market
Price
D
D1
S
The Firm
Price
MC
AVC
PE
QE Q* E
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Quantity
10 11
Impact of a Decrease in Demand
The Market
Price
D2
D
The Firm
S
Price
AVC
MC
PE
Q* E Q E
9 10
Quantity
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Firm is a Price Taker in the
Input Market
Wage
Rate
Labor Market
SL
DL
Wage
Rate
The Firm
MVP
MIC
PL
QL
LF
Labor
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Firm is a Price Taker in the
Input Market
Labor Market
Wage
Rate
DL*
SL
DL
Wage
Rate
The Firm
MVP
PL
MIC
QL
50
Labor
L*F
LF
Effects of Increasing The
Minimum Wage
Wage
Rate
Labor Market
D
S
Wage
Rate
The Firm
MVP
PMIN
MIC
LMAX
QD QS
Labor
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Summary
Market equilibrium price and quantity are
given by the intersection of demand and supply
Producer surplus captures the profit earned in
the market by producers
Total economic surplus is equal to producer
surplus plus consumer surplus
A market surplus exists when the quantity
supplied exceeds the quantity demanded.
A market shortage exists when the quantity
demanded exceeds the quantity supplied.
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Chapter 9 focuses on market
equilibrium and product prices
under conditions of imperfect
competition….
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