Transcript Slide 1

Demand, Supply, and Equilibrium
in a Perfectly Competitive Market
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The Context: “Perfectly Competitive Markets”
• A group of buyers and sellers of a particular good or service
– can be defined narrowly or broadly (e.g., rice vs. food)
– at a given point in time (e.g., day, month, year)
• Enough buyers and sellers so that no one has an impact on the price
– typical with many buyers and sellers
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Willingness to Pay
• Willingness to pay (WTP): the maximum amount that a buyer will pay for
a good
• Further distinctions are helpful…
• Marginal willingness to pay (MWTP): WTP for one more unit of a good
• Total willingness to pay (TWTP): WTP for any number of units of a good
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An Individual’s WTP for good X
Quantity of X Marginal WTP
(MWTP)
Total WTP
(TWTP)
1
$4
$4
2
$3
$7
3
$2
$9
4
$1
$10
5
$0
$10
5
4
An Individual’s Demand Curve
• A graph of an individual’s MWTP curve is her demand curve
• Demand curve: gives the relationship between the price of a good and the
quantity demanded
• Law of demand: downward sloping curve reflects diminishing MWTP
5
An Individual’s Demand Schedule
• A table that gives the relationship
between the price and quantity
demanded
Price of X
Quantity
Demanded
$5
0
• Based on the individual’s MWTP
$4
1
$3
2
$2
3
$1
4
$0
5
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Consider a Market with Two Individuals
Price of X
Individuals 1’s
Quantity Demanded
Individual 2’s
Quantity Demanded
Total
Quantity Demanded
$5
0
0
0
$4
1
2
3
$3
2
4
6
$2
3
6
9
$1
4
8
12
$0
5
10
15
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The Market (Aggregate) Demand Curve
• A horizontal summation of individual demand curves
• Tells the market quantity demanded at any given price
• Also tells the MWTP in the market—the most someone is WTP for each
additional unit of the good
8
A Note on Demand Semantics
• Changes in price result in “changes in the quantity demanded”
• “Changes in demand” imply shifts of the demand curve
9
Shifters of the Demand Curve
1. Changes in income, + (-)
• Normal goods, + (-)
• Inferior goods, - (+)
2. Changes in the price of related goods, + (-)
• Substitutes, + (-)
• Complements, - (+)
3. Tastes and preferences
4. Expectations
5. Number of buyers in the market, + (-) implies + (-)
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A Firm’s Marginal Cost (MC) of Production
• Marginal cost (MC): tells a firm’s incremental cost of producing an
additional unit of a good
• We assume it is increasing (for now)
• We ignore the total costs of production (for now)
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A Firm’s MC of Producing Good X
Quantity of X
MC
1
$2
2
$3
3
$4
4
$5
5
$6
12
An Firm’s Supply Curve
• A graph of a firm’s MC curve is its supply curve
• Supply curve: gives the relationship between the price of a good and the
quantity supplied
• Law of supply: upward sloping curve reflects increasing MC
13
A Firm’s Supply Schedule
• A table that gives the relationship
between the price and quantity
supplied
• Based on the firm’s MC
Price of X
Quantity
Supplied
$1
0
$2
1
$3
2
$4
3
$5
4
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Consider a Market with Two Firms
Price of X
Firm 1’s
Quantity Supplied
Firm 2’s
Quantity Supplied
Total
Quantity Supplied
$1
0
0
0
$2
1
2
3
$3
2
4
6
$4
3
6
9
$5
4
8
12
15
The Market (Aggregate) Supply Curve
• A horizontal summation of the individual firm supply curves
• Tells the market quantity supplied at any given price
• Also tells the MC in the market—the lowest cost of producing each
additional unit of the good
16
A Note on Supply Semantics
• Changes in price result in “changes in the quantity supplied”
• “Changes in supply” imply shifts of the supply curve
17
Shifters of the Supply Curve
1. Changes in input prices, + (-) implies - (+)
2. Changes in the technology of production, such that better
(worse) implies + (-)
3. Expectations
4. Number of sellers in the market, + (-) implies + (-)
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Equilibrium: Supply “meets” Demand
• The intersection of the supply and demand curves determines the
equilibrium price and quantity
• Market clearing condition: when the quantity supplied equals the quantity
demanded
• Given the equations for the supply and demand curves, you can solve
algebraically for P* and Q*
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Equilibrium Proof by Contradiction
• If P > P*, then there would be excess supply (a surplus)
– Firms would lower prices
• If P < P*, then there would be excess demand (a shortage)
– Consumers would pay more
• Must be true that P = P* and that QS = QD = Q*
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Comparative Static Analysis
Ceteris paribus : other things being equal
• An increase (decrease) in demand results in more (less) exchange at a
higher (lower) price
• An increase (decrease) in supply results in more (less) exchange at a
lower (higher) price
• Simultaneous shifts in supply and demand can generate ambiguous
effects
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