How do Supply & Demand Get Together to Make Markets? Agenda: What is Competition? Birds & Bees Review A. Where do demand curves come from? Where do supply curves come from? Industry supply curves (new math!) How do demand and supply get together to make markets? A. Assumptions underlying perfect competition B. A continuum of competition Go back to birds and bees…

What does “competition” mean to you? Scarcity – both parties can’t have the same thing At least two parties “a fair fight” – rules, referee, “reciprocity” (Ouchi) Can be either short or long term

Pay attention to what is on the X and Y axes! So Where DO Demand Curves Come From? composite good quantity Price What is the price of shelter at this budget constraint? KEY: Pay attention to what is on the X and Y axes! At this price, what is the optimal quantity of shelter? Does demand have anything to do with the number of competitors in the market? Test yourself: Does demand have anything to do with the number of competitors in the market?

Slutsky & Elasticity Re-write the way we have written elasticities with x = Q for quantity of X Multiply both sides by P/Q, the last term by M/M and re-arrange M and Q NOTE: You will need to draw demand curves and write your justification of HOW you draw them for your end-of-semester market analysis essay! Own price elasticity = compensated price elasticity – share of income * income elasticity Test yourself: Pick a product/service and draw the demand as a function of both the substitution and income effects.

MARKET demand curves sum individual demand curves. Larger substitution & income effects Smaller substitution & income effects We don’t do the math of summing individual demand curves – need to deal with functional form for utility, which is sticky! My personal pet peeve. But we WILL sum the market supply curves.

Where Do Supply Curves Come From? Supply Curves are MC curves ABOVE the minimum AVC! Short-run Individual firm supply curve Why not here?? Here’s a graph that relates price and quantity… What if price is here? Economic loss! Shutdown! P<AVC Test yourself: Does the supply curve have anything to do with fixed costs?

The market supply is simply the sum of the individual firm supplies! Market Supply Curve The market supply is simply the sum of the individual firm supplies! Firm Supply curve: Quantity: Industry Supply: 100 firms each have identical supply curves: P = 5 + 200Q What is the industry supply curve? Vocabulary: note the difference between supply = Q and supply curve, which is a function P = f(Q) A SUPPLY CURVE IS A FUNCTION THAT MAPPS QUANTITY TO PRICES Supply = quantity Need to sum quantities! Solve for Q Multiply by n Solve for P TEST YOURSELF: What if firms did NOT have identical supply curves?

Price Depends on Assumptions! 1. Are Products THE SAME (standardized, commodities)? 2. Are there barriers to firms entering or exiting? No barriers to entry include free entry and exit of capital and labor in the long run. KEY: number of competitors you OBSERVE in a market is an effect of these assumptions, NOT a cause of market structure. 3. Are there a lot of buyers and sellers? 4. Is there perfect information (no transactions costs)?

Monopolistic Competition A Continuum of Competition…. Key questions: Is there meaningful product differentiation? Are there significant barriers to entry or exit? Perfect Competition Monopolistic Competition Oligopoly Monopoly Causes of monopoly: Economies of scale (production technology – go back to gnomes), regulation (we don’t want everyone tearing up the roads to lay gas pipe, we want to know who to go to when something blows up) Network externalities, Location (also a form of product differentiation) Patents Of the four assumptions underlying perfect competition, really only two are important: product differentiation and barriers to entry/exit. Pricing power comes from these (assumption #2) and we never have perfect information (transactions costs)