Lecture 4: market and equilibrium Advanced Micro Theory MSc.EnviNatResEcon. 1/2006 Charit Tingsabadh

Review of Economics Session 1 Markets and market processes To create value, organisations need to understand their environment Two levels of environment: The contextual environment (remote/macro). The transactional environment.

Markets are part of the organisation’s transactional environment We look at markets in a broad, abstract way. Analysis applies to commercial and not-for-profit organisations. But remember that events and processes in the contextual environment impact the organisation through market forces.

Markets For the moment, forget individual businesses Think about the all suppliers - the “industry”

The market process A market is a process of interaction between buyers and sellers Both sides matter.

Objectives of market participants Consumers (demanders) seek to maximise value from the satisfaction of their wants and needs Producers (suppliers) seek to maximise added value

Demand and supply analysis We can analyse markets using the notions of Market demand and Market supply These turn out to give us a tremendously powerful way of marshalling our thoughts.

Market demand for a product … depends on customers’ willingness to pay it. This, in turn, depends on tastes or preferences price relative to other products consumers’ income

Market supply of a good … depends on the how many businesses are willing and able to sell products at various prices. This, in turn, depends on input/raw material prices the state of technology the price of the good relative to the prices of other goods

MARKET EQUILIBRIUM A market is in equilibrium when supply and demand are balanced, so that the price has no tendency to change from its current level.

Equilibrium Price and Quantity Traded Price of product Quantity demanded/supplied of product per time period Q1Q1 P1P1 S D

Excess demand, excess supply and price adjustments Price of good X Quantity demanded/supplied of good X per time period Q1Q1 P1P1 S D P2P2 Excess supply QDQD Qs

Does this work for desktop PC’s? Price of PC Quantity demanded/supplied of PCs per time period Q1Q1 P1P1 S D

CHANGES IN MARKET PRICE ARISE FROM Anything that changes the conditions of demand or Anything that changes the conditions of supply

An increase in demand Price of good X Quantity demanded/supplied of good X per time period Q1Q1 P1P1 S D1D1 D2D2 Q2Q3 P2P2

LET US TRY TO DEDUCE WHAT HAPPENS TO MARKET PRICE IN THE FOLLOWING CASES: The product has a successful advertising campaign (by all competitors together) The economy has an exchange rate appreciation Wage costs rise Technological progress takes place

Applications of market analysis The market for crude oil and supply side interruptions. The market for heroin: supply side and demand side interventions The UK National Health Service and waiting lists

$10 D S, pre-war S, post-war 1990: The Gulf war and its effect on the price of crude oil 52 Million barrels/day

$10 $40 D S, pre-war S, post-war 1990: The Gulf war and its effect on the price of crude oil 5248 Mill b/day

The market for heroin Price Quantity per period P1P1 Q1Q1 Supply Demand

The market for heroin Price Quantity per period P1P1 Q1Q1 Q2Q2 P2P2 Supply Demand

The market for heroin Price Quantity per period P1P1 Q1Q1 P2P2 Supply Demand New Supply

A private health service Price Quantity per period P1P1 Q1Q1 Market supply Demand

A publicly provided health service Price Quantity per period P1P1 Q1Q1 Q2Q2 P2P2 Imputed market supply Demand Q*

A health service dilemma: more supply adds to demand Price Quantity per period P1P1 Q1Q1 Q2Q2 P2P2 Imputed market supply Demand New demand Q3Q3

Reading and further issues Perman and Scouller, Business Economics, Chapter 2

Task 1 Select one business that one organisation of which you are aware is involved in. What market does this business operate in? Answer these questions for the market as a whole, not a single business Using PEST analysis, identify any important changes in external conditions that might affect market supply or demand. Which, if any, of these changes affect demand conditions in that market? Which, if any, of these changes affect supply conditions in that market? Using a supply and demand sketch diagram, illustrate how these changes might affect market demand and supply (this analysis need only be qualitative).

Chapter 9 Applying the Competitive Model

Figure 9.1 Consumer Surplus

Figure 9.1a Consumer Surplus

Figure 9.1b Consumer Surplus

Figure 9.2 Fall in Consumer Surplus From Roses as Price Rises

Table 9.1 Effect of a 10% Increase in Price on Consumer Surplus (Revenue and Consumer Surplus in Billions of 1999 Dollars)

Page 278 Solved Problem 9.1

Figure 9.3 Producer Surplus

Figure 9.3a Producer Surplus

Figure 9.3b Producer Surplus

Page 281 Solved Problem 9.2

Figure 9.4 Why Reducing Output from the Competitive Level Lowers Welfare

Figure 9.5 Why Increasing Output from the Competitive Level Lowers Welfare

Figure 9.6 Effect of a Restriction on the Number of Cabs

Figure 9.7 Welfare Effects of a Specific Tax on Roses

Figure 9.8 Welfare Effects of a Per-Unit Subsidy on Roses

Figure 9.9 Effect of Pricing Supports in Soybeans

Page 298 Solved Problem 9.3

Page 300 Solved Problem 9.4

Figure 9.10 Loss from Eliminating Free Trade

Figure 9.11 Effect of a Tariff (or Quota)

Table 9.2 Welfare Cost of Trade Barriers (millions of 1999 Dollars)