Principles of Microeconomics Shomu Banerjee 3. Competitive markets Emory University Spring 2013

Competitive markets No single person believes that s/he can influence the market price Potential buyers: Potential sellers: Everyone is a price-taker

Other assumptions Standardized (homogeneous) product Relatively short time period Specific geographical area Information is available instantaneously and costlessly

Demand curve Maximum willingness to pay Ali: $8 Bob: $7 Carl: $6 Price Maximum willingness to pay Ali: $8 Bob: $7 Carl: $6 Don: $5 Eli: $4 Flo: $3 Gigi: $2 10 5 5 10 Quantity

Supply curve Minimum willing to accept Hal: $3 Ila: $3 Jon: $4 Kay: $5 Price Minimum willing to accept Hal: $3 Ila: $3 Jon: $4 Kay: $5 Lee: $6 Matt: $6 Nell: $7 10 5 5 10 Quantity

Market Equilibrium Price A price P* is an equilibrium price if the quantity demanded at that price equals the quantity supplied at that price; this quantity Q* is the equilibrium quantity. Quantity 5 10 4 E F G L M N

Gains from trade • Consumer surplus: • Producer surplus: Price 10 A B 5 K J H I 4 5 10 Quantity

Market Equilibrium GFT Price A 1 10 5 2 4 3 6 7 8 9 A - G = 8 B - H = 6 C - I = 4 D - J = 2 E - K = 0 B C D E L K F J I H G GFT = 20 Quantity

Market Equilibrium GFT Price Value to society from 5 trades A 1 10 5 2 4 3 6 7 8 9 B C D A + B + C + D + E -(G + H + I + J + K) E L K F J I H “Cost” to society from 5 trades G GFT = 20 Quantity

Market Matching GFT GFT = 18! A + B + C + D + E + F Price Value to society from 6 trades = 45 A 1 10 5 2 4 3 6 7 8 9 B C D A + B + C + D + E + F -(G + H + I + J + K + L) E L K F J I H “Cost” to society from 6 trades = 37 G GFT = 18! Quantity

Market Equilibrium Price A “Cost” to society of 6th trade 1 10 5 2 4 3 5 2 4 3 6 7 8 9 B C D E L K F J Value to society of 6th trade I H G Quantity

Stability Price 10 5 • At $7: • At $3: 4 5 10 Quantity Excess supply Excess demand • At $3: 4 5 10 Quantity

Determinants of demand Price Income Prices of other goods Tastes Price expectations # of consumers 5 Price 10 Fixed • Income • Prices of other goods • Tastes • Price expectations • Number of consumers Initial demand 5 10 Quantity

Income +: Normal good –: Inferior good 5 Price 10 5 Price 10 5 10 5 10 New demand with higher income B’ B B B’ Initial demand New demand with higher income Initial demand 5 10 5 10 Quantity Quantity

with higher price of complement Prices of other goods +: Substitute –: Complement 5 Price 10 5 Price 10 A’ A A A’ New demand with higher price of substitute B’ B B B’ Initial demand New demand with higher price of complement Initial demand 5 10 5 10 Quantity Quantity

with increase in tastes Price 10 A’ A New demand with increase in tastes 5 B’ B Initial demand 5 10 Quantity

Increase in demand determinants Income +/– Price of substitutes + Price of complements – Tastes + Price expectations + # of consumers + Change in demand = Shift in demand

Determinants of supply Price Input prices Prices of other goods Technology Price expectations # of producers 5 Price 10 Initial supply Fixed • Input prices • Prices of other goods • Technology • Price expectations • Number of producers 5 10 Quantity

with increase in input prices New supply with increase in input prices 10 A’ A 5 B’ B Initial supply 5 10 Quantity

Increase in supply determinants Input prices – Technology + Price expectations + # of producers + Prices of related goods +/–