Intermediate Micro Theory Overview of Market Outcomes

Ultimate goal of this class is describe: How market outcomes (prices and quantities) are determined, How such outcomes can be affected by government policy or other shocks to the economy. So far, we have considered the demand side in depth. However, we have been using an overly simplistic model of supply side. We now want to consider how outcomes are determined in a world with more complicated production processes. To do so, we must consider what kind of a market framework we will use.

Overview of Market Outcomes (cont.) Our basic building block model will be “perfect competition” “Perfectly competitive” industries. 1. Product is relatively homogeneous across suppliers. 1. Like consumers, firms are “price takers”. 1. In long-run, factors of production are perfectly mobile. 1. Perfect information on the part of consumers and firms Examples?

Overview of Market Outcomes (cont.) Other market structures? Why focus on pure competition? Most natural? Most prevalent? Useful starting point? Market outcomes under perfect competition can help us understand both the limits of markets in general, as well as what may be some pitfalls inherent in other market structures.

Market Outcomes Under Perfect Competition Market outcomes in any given market dictated by interaction of two sides: 1. Market Demand Q d (p) – how the amount of a given good demanded will adjust with its price. Generally a negative relationship. 2. Market Supply Q s (p) - how the amount of a good supplied will adjust with its price. Generally a (weakly) positive relationship. Given Q d (p) and Q s (p), what will be the market equilibrium price and quantity?

Overview of Firm Behavior We have already developed our theory of demand, giving Q d (p). So for the next several weeks, we will develop our theory of firm behavior and market supply Q s (p). Will be done in three steps: 1. How firm converts inputs into the output (Technology) Gives us factor demand curves 2. Given firm’s choice of how to best convert inputs into output, how much firm will supply to the market at any given price. Gives us firm supply curve 3. How much in total will be supplied to the market Gives us industry supply curve We will then return to this equilibrium model and discuss it in more depth.