Lecture Five: Competitive Market IPEM Tohoku University Managerial Economics Lecturer: Jack Wu Period 1 and 2/ February 16

Perfect Competition homogeneous product many buyers many sellers price takers free entry and exit equal information

Perfect competition In market where products are differentiated, competition is not as keen as that in a market where products are homogeneous. Compare mineral water – differentiated gold – pure commodity

Perfect competition Many small buyers Many small sellers buyer/seller with market power can influence demand/supply Market where some buyers have market power different buyers pay different prices; buyers with market power get lower prices; not possible to construct a market demand curve. Similarly, where some sellers have market power

Perfect competition Free entry and exit No entry barriers to potential competitors No exit barriers to existing sellers

Free Entry? Japanese Beer Market, pre-’94: Ministry of Finance production licenses for minimum of 2 million liters a year sales licenses limited to small family-owned stores

Perfect competition Market with differences in information not as competitive as one where all buyers and sellers have equal information Compare photocopying service medical treatment legal advice Medical treatment: patients have less information than doctors not all doctors equally informed about current medical technology and regulations Market for medical treatment is less competitive. Similarly, market for legal advice is less competitive.

Market Equilibrium, I Price at which quantity demanded equals quantity supplied when market out of equilibrium, market forces push price towards equilibrium

MARKET EQUILIBRIUM, II a excess supply supply Price ($ per ton-mile) 22 b 20 equilibrium c demand 8 10 11 Quantity (Million ton-miles a year)

Market Equilibrium, III excess supply = excess of quantity supplied over quantity demanded triggers price decrease excess demand = excess of qty demanded over qty supplied triggers price increase

Supply Shift, I supply shifts down (right) -> lower price, larger quantity supply shifts up (left) -> higher price, smaller quantity final equilibrium depends on elasticities of demand and supply

SUPPLY SHIFT, II a original supply Price ($ per ton-mile) b 60 cents 20 new supply 19.60 d demand 60 cents c e 10 10.4 Quantity (Million ton-miles a year)

Price Elasticities of Demand Extremely inelastic demand Extremely elastic demand demand original supply original supply b Price ($ per ton-mile) 60 cents 60 cents new supply 20 Price ($ per ton-mile) 20 b demand new supply 19.40 60 cents 60 cents c c e e 10 10 10.6 Quantity (Million ton-miles a year) Quantity (Million ton-miles a year)

PRICE ELASTICITIES OF SUPPLY Extremely inelastic supply Extremely elastic supply original and new supply a a original supply b 20 b 20 Price ($ per ton-mile) Price ($ per ton-mile) 60 cents 60 cents 19.40 new supply demand demand 10 10 11 Quantity (Million ton-miles a year) Quantity (Million ton-miles a year)

Supply Shift: Price Impact price change no more than amount of the supply shift price change smaller if demand is more elastic than supply larger if supply is more elastic than demand

PROMOTING RETAIL SALES retail supply after wholesale price cut a Price ($ per unit) 1.50 b retail demand 1 Q Quantity (Million units a year)

Demand Shift, I demand shifts down (left) -> lower price, lower quantity demand shifts up (right) -> higher price, larger quantity final equilibrium depends on elasticities of demand and supply

DEMAND SHIFT, II supply a 1 million f b Price ($ per ton-mile) 20 new demand 1 million original demand c 10 10.8 Quantity (Million ton-miles a year)

Tanker services, 2005 Increasing oil prices Increasing China imports Higher costs for tanker services  supply curve up Increasing China imports Higher demand for tanker services More stringent tanker standards Non-complying tankers scrapped  supply curve shifted to left

Valentine’s Day Nearing Valentine’s Day, price of roses always rises much more than the price of greeting cards. Why?

Calculating Equilibrium, I How would 3% increase in income affect price and sales of gasoline? demand price elasticity -.23 income elasticity 0.39 supply price elasticity 0.62

Calculating Equilibrium, II % change in qty demanded = -0.23 %p + 0.39 x 3 % change in qty supplied = 0.62 %p equate and solve: %p = 1.38% % change in qty = 0.87%

SHORT-RUN MARKET EQUILIBRIUM (a) Individual seller (b) Market short-run marginal cost short-run supply short-run average variable cost 1 million c 22 Price ($per ton-mile) 22 Price ($ per ton-mile) 20 20 a price short-run demand 100 105 10 12 Quantity (Thousand ton-miles a year) Quantity (Thousand ton-miles a year)

LONG-RUN MARKET EQUILIBRIUM (a) Individual seller (b) Market new long-run average cost long-run marginal cost long-run supply 1 million d Price ($per ton-mile) Price ($ per ton-mile) 21 21 20 20 a original long- run average cost long-run demand 100 10 13 Quantity (Thousand ton-miles a year) Quantity (Thousand ton-miles a year)

Short/Long-Run Impact If demand/supply shifts, market price is more volatile in the short run than long run greater change in market quantity over the long run than short run

Demand increase This figure combines short-run with long-run analysis at market level

Demand reduction This figure combines short-run with long-run analysis at market level

Pricing and Freight Cost, I cost and freight ex-works pricing How does pricing policy affect sales?

PRICING AND FREIGHT COST, II CF supply 25 cents 25 cents ex-works supply a Price ($ per pound) 1.50 b CF demand ex-works demand 1 Quantity (Million pounds a year)

Retailing: Why coupons? alternative -- cutting wholesale prices “With coupons, prevent retailers from getting part of price cut.”