Download KOF - Webarchiv ETHZ / Webarchive ETH

5
Competitive Markets
Introduction to Economics
ETH Zürich, Prof. Dr. Jan-Egbert Sturm
Winter Term 2006/07
Exam
• Date:
Tuesday, February 13, 2007
• Time:
15:15 – 16:45 (90 minutes)
• Place:
HG E 7
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
General Information
24.10.
Introduction; Transformation Curve, Opportunity Cost
Mankiw ch.1,2
31.10.
Markets: Demand and Supply
Ch. 4
7.11.
Elasticities
Ch. 5
14.11.
Costs, Production Function
Ch. 13
21.11.
Markets with perfect competiton
Ch. 7, 14
28.11.
Taxation
Ch. 8
5.12.
International Trade
Ch. 9
12.12.
Imperfect competition: Monopoly, and Oligoploy
Ch. 15, 16
19.12.
Public Goods, Externalities
Ch. 10,11
9.1.
National Accounting, Gross Domestic Product, Growth
Ch. 23, 25
16.1.
Money and Inflation
Ch. 24, 29, 30
23.1.
Business Cycles
Ch. 33, 34
30.1.
Open Economy Macro
Ch. 31
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
WHAT IS A COMPETITIVE MARKET?
• A perfectly competitive market has the
following characteristics:
• There are many buyers and sellers in the market.
• The goods offered by the various sellers are
largely the same.
• Firms can freely enter or exit the market.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
WHAT IS A COMPETITIVE MARKET?
• As a result of its characteristics, the perfectly
competitive market has the following
outcomes:
• The actions of any single buyer or seller in the
market have a negligible impact on the market
price.
• Each buyer and seller takes the market price as
given.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
WHAT IS A COMPETITIVE MARKET?
• A competitive market has many buyers and
sellers trading identical products so that
each buyer and seller is a price taker.
• Buyers and sellers must accept the price
determined by the market.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
PROFIT MAXIMIZATION AND THE
COMPETITIVE FIRM’S SUPPLY CURVE
• The goal of a competitive firm is to
maximize profit.
• This means that the firm will want to
produce the quantity that maximizes the
difference between total revenue and total
cost.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 1 Profit Maximization for a Competitive Firm
•Long run supply is given by the part of marginal cost
curve above average total cost
Cost
per Unit
MC
The firm maximizes profits
by producing the quantity at
which MC=MR
800
600
ATC
Price=MR
400
200
0
0
5
10
15
20
Quantity
Figure 2 Market Supply
Company A
Company B
Supply B
Supply A
Cost
per Unit
Cost
per Unit
600
290
15
15
Quantity
Quantity
Companies A + B
Supply A
Supply A+B
Preis
600
290
15
30
Quantity
Î
Market supply is the sum of
the single firms‘ supply.
Î
As long as firms make
profits, market entry takes
place
Figure 3 Market Entry
2
3
5
4
1
Number of Firms:
Price
800
640
600
490
410
400
340
290
Market entry until MC=MR=Price
200
Demand
0
0
20
40
60
80
Quantity
Figure 4 Market Equilibrium
Zero Demand at 5.8$
Supply
Price per unit
8
Demand
6
4
Minimum of ATC
2
Revenue covers AVC
No supply at prices
below 1.8 $. 0
0
100
200
Quantity
300
400
500
Figure 5 Market Equilibrium
market price = 4
Supply
price per unit
8
Demand
6
4
2
quantity traded=240
0
0
100
200
Quantity
300
400
500
Figure 6 Market Equilibrium
Consumers can buy the
quantity they demand at the
given price
Producers can sell the quantity
they want to produce at the given
price.
Supply
price per unit
8
Demand
6
Market equilibrium
4
2
0
0
100
200
Quantity
300
400
500
The Long Run: Market Supply with Entry and
Exit
• At the end of the process of entry and exit,
firms that remain must be making zero
economic profit.
• The process of entry and exit ends only
when price and average total cost are driven
to equality.
• Long-run equilibrium must have firms
operating at their efficient scale.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Why Do Competitive Firms Stay in Business If
They Make Zero Profit?
• Profit equals total revenue minus total cost.
• Total cost includes all the opportunity costs
of the firm.
• In the zero-profit equilibrium, the firm’s
revenue compensates the owners for the
time and money they expend to keep the
business going.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Market mechanics
• at all other prices, there will be excess
supply or excess demand
• Market mechanics will bring the market
back to equilibrium
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 8 Market Equilibrium
price too low
supply too low, demand
cannot be fully satisfied
Supply
price per unit
8
Demand
6
excess demand
4
3
2
Demand
Supply
0
0
100
200
Quantity
300
400
500
Figure 9 Market Equilibrium
price too low
demand cannot be fully
satisfied
Supply
price per unit
8
Producers can raise
prices without losing
customers
Demand
6
4
3
2
price rises excess demand
disappears
0
0
100
200
Quantity
300
400
500
Figure 10 Market Equilibrium
price too high
Part of the production
cannot be sold
Supply
price per unit
8
Price must fall for
goods to be sold
Demand
6
5
4
Price falls-excess
supply disappears
2
0
0
100
200
Quantity
300
400
500
A Shift in Demand in the Short Run and
Long Run
• An increase in demand raises price and
quantity in the short run.
• Firms earn profits because price now
exceeds average total cost.
• In the long run, new firms will enter the
market until profits are zero.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 11 Market Dynamics: higher income
price
per unit
demand at higher income
short run supply
8
6
demand
Short run supply (after
market entry new firms)
2
3
1
4
long run supply
2
100
200
Quantity
300
400
500
REVISITING THE MARKET
EQUILIBRIUM
• Do the equilibrium price and quantity
maximize the total welfare of buyers and
sellers?
• Market equilibrium reflects the way markets
allocate scarce resources.
• Whether the market allocation is desirable
can be addressed by welfare economics.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Welfare Economics
• Welfare economics is the study of how the
allocation of resources affects economic
well-being.
• Buyers and sellers receive benefits from
taking part in the market.
• The equilibrium in a market maximizes the
total welfare of buyers and sellers.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Welfare Economics
• Equilibrium in the market results in
maximum benefits, and therefore
maximum total welfare for both the
consumers and the producers of the
product.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Welfare Economics
• Consumer surplus measures economic
welfare from the buyer’s side.
• Producer surplus measures economic
welfare from the seller’s side.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
CONSUMER SURPLUS
• Willingness to pay is the maximum amount
that a buyer will pay for a good.
• It measures how much the buyer values the
good or service.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
CONSUMER SURPLUS
• Consumer surplus is the buyer’s willingness
to pay for a good minus the amount the
buyer actually pays for it.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Table 1 Four Possible Buyers’ Willingness to Pay
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Copyright©2004 South-Western
CONSUMER SURPLUS
• The market demand curve depicts the
various quantities that buyers would be
willing and able to purchase at different
prices.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
The Demand Schedule and the
Demand Curve
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 1 The Demand Schedule and the Demand Curve
Price of
Album
John’s willingness to pay
$100
Paul’s willingness to pay
80
George’s willingness to pay
70
Ringo’s willingness to pay
50
Demand
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
1
2
3
4
Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Figure 2 Measuring Consumer Surplus with the Demand
Curve
(a) Price = $80
Price of
Album
$100
John’s consumer surplus ($20)
80
70
50
Demand
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
1
2
3
4
Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Figure 2 Measuring Consumer Surplus with the Demand
Curve
(b) Price = $70
Price of
Album
$100
John’s consumer surplus ($30)
80
Paul’s consumer
surplus ($10)
70
50
Total
consumer
surplus ($40)
Demand
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
1
2
3
4 Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Using the Demand Curve to Measure
Consumer Surplus
• The area below the demand curve and above
the price measures the consumer surplus in
the market.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 3 How the Price Affects Consumer Surplus
(a) Consumer Surplus at Price P
Price
A
Consumer
surplus
P1
B
C
Demand
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Q1
Quantity
Copyright©2003 Southwestern/Thomson Learning
Figure 3 How the Price Affects Consumer Surplus
(b) Consumer Surplus at Price P
Price
A
Initial
consumer
surplus
P1
P2
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
C
B
Consumer surplus
to new consumers
F
D
E
Additional consumer
surplus to initial
consumers
Q1
Demand
Q2
Quantity
Copyright©2003 Southwestern/Thomson Learning
What Does Consumer Surplus Measure?
• Consumer surplus, the amount that buyers
are willing to pay for a good minus the
amount they actually pay for it, measures
the benefit that buyers receive from a good
as the buyers themselves perceive it.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
PRODUCER SURPLUS
• Producer surplus is the amount a seller is
paid for a good minus the seller’s cost.
• It measures the benefit to sellers
participating in a market.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Table 2 The Costs of Four Possible Sellers
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Copyright©2004 South-Western
Using the Supply Curve to Measure Producer
Surplus
• Just as consumer surplus is related to the
demand curve, producer surplus is closely
related to the supply curve.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
The Supply Schedule and the Supply
Curve
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 4 The Supply Schedule and the Supply Curve
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Using the Supply Curve to Measure Producer
Surplus
• The area below the price and above the
supply curve measures the producer surplus
in a market.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 5 Measuring Producer Surplus with the Supply Curve
(a) Price = $600
Price of
House
Painting
Supply
$900
800
600
500
Grandma’s producer
surplus ($100)
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
1
2
3
4
Quantity of
Houses Painted
Copyright©2003 Southwestern/Thomson Learning
Figure 5 Measuring Producer Surplus with the Supply Curve
(b) Price = $800
Price of
House
Painting
$900
Supply
Total
producer
surplus ($500)
800
600
Georgia’s producer
surplus ($200)
500
Grandma’s producer
surplus ($300)
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
1
2
3
4
Quantity of
Houses Painted
Copyright©2003 Southwestern/Thomson Learning
Figure 6 How the Price Affects Producer Surplus
(a) Producer Surplus at Price P
Price
Supply
P1
B
Producer
surplus
C
A
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Q1
Quantity
Copyright©2003 Southwestern/Thomson Learning
Figure 6 How the Price Affects Producer Surplus
(b) Producer Surplus at Price P
Price
Supply
Additional producer
surplus to initial
producers
P2
P1
D
E
F
B
Initial
producer
surplus
C
Producer surplus
to new producers
A
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
0
Q1
Q2
Quantity
Copyright©2003 Southwestern/Thomson Learning
MARKET EFFICIENCY
• Consumer surplus and producer surplus
may be used to address the following
question:
• Is the allocation of resources determined by free
markets in any way desirable?
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
MARKET EFFICIENCY
Consumer Surplus
= Value to buyers – Amount paid by buyers
and
Producer Surplus
= Amount received by sellers – Cost to sellers
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
MARKET EFFICIENCY
Total surplus
= Consumer surplus + Producer surplus
or
Total surplus
= Value to buyers – Cost to sellers
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
MARKET EFFICIENCY
• Efficiency is the property of a resource
allocation of maximizing the total surplus
received by all members of society.
• An allocation is Pareto efficient if no
individual can be made better off without
another being made worse off
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
MARKET EFFICIENCY
• In the equilibrium of a competitive market
• the sum of consumer surplus and producer
surplus is maximized
• consumer surplus cannot be raised without
lowering producer surplus
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 7 Consumer and Producer Surplus in the Market
Equilibrium
Price A
D
Supply
Consumer
surplus
Equilibrium
price
E
Producer
surplus
B
Demand
C
0
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Equilibrium
quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning
MARKET EFFICIENCY
• Three Insights Concerning Market
Outcomes
• Free markets allocate the supply of goods to the
buyers who value them most highly, as
measured by their willingness to pay.
• Free markets allocate the demand for goods to
the sellers who can produce them at least cost.
• Free markets produce the quantity of goods that
maximizes the sum of consumer and producer
surplus.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Figure 8 The Efficiency of the Equilibrium Quantity
Price
Supply
Value
to
buyers
Cost
to
sellers
Cost
to
sellers
0
Value
to
buyers
Equilibrium
quantity
Value to buyers is greater
than cost to sellers.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Demand
Quantity
Value to buyers is less
than cost to sellers.
Copyright©2003 Southwestern/Thomson Learning
Evaluating the Market Equilibrium
• Because the equilibrium outcome is an
efficient allocation of resources, the social
planner can leave the market outcome as
he/she finds it.
• This policy of leaving well enough alone
goes by the French expression laissez faire.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Summary
• To maximize profit, a firm chooses the
quantity of output such that marginal
revenue equals marginal cost.
• This is also the quantity at which price
equals marginal cost.
• Therefore, the firm’s marginal cost curve is
its supply curve.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Summary
• In the short run, when a firm cannot recover
its fixed costs, the firm will choose to shut
down temporarily if the price of the good is
less than average variable cost.
• In the long run, when the firm can recover
both fixed and variable costs, it will choose
to exit if the price is less than average total
cost.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Summary
• In a market with free entry and exit, profits
are driven to zero in the long run and all
firms produce at the efficient scale.
• Changes in demand have different effects
over different time horizons.
• In the long run, the number of firms adjusts
to drive the market back to the zero-profit
equilibrium.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Summary
• Consumer surplus equals buyers’
willingness to pay for a good minus the
amount they actually pay for it.
• Consumer surplus measures the benefit
buyers get from participating in a market.
• Consumer surplus can be computed by
finding the area below the demand curve
and above the price.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Summary
• Producer surplus equals the amount sellers
receive for their goods minus their costs of
production.
• Producer surplus measures the benefit
sellers get from participating in a market.
• Producer surplus can be computed by
finding the area below the price and above
the supply curve.
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF
Summary
• An allocation of resources that maximizes the sum
of consumer and producer surplus is said to be
efficient.
• The equilibrium of demand and supply maximizes
the sum of consumer and producer surplus.
• This is as if the invisible hand of the marketplace
leads buyers and sellers to allocate resources
efficiently.
• Free markets ensure a (pareto-)efficient allocation
Konjunkturforschungsstelle
Swiss Institute for
Business Cycle Research
KOF