Competitive Markets

Frontline Source: Frontline, Reproduced with permission

3 (c) , I.P.L. Png & D.E. Lehman Oil tanker market, 2005  Impact of  Increasing oil prices  Increasing China imports  More stringent tanker standards

4 (c) , I.P.L. Png & D.E. Lehman Outline  perfect competition  market equilibrium  supply shift  demand shift  adjustment time

5 (c) , I.P.L. Png & D.E. Lehman Perfect competition  homogeneous product  many buyers  many sellers  free entry and exit  equal information

6 (c) , I.P.L. Png & D.E. Lehman 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

7 (c) , I.P.L. Png & D.E. Lehman Perfect competition  Many small buyers  Many small sellers  buyer/seller with market power can influence demand/supply

8 (c) , I.P.L. Png & D.E. Lehman Perfect competition  Free entry and exit  No entry barriers to potential competitors  No exit barriers to existing sellers

9 (c) , I.P.L. Png & D.E. Lehman 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

10 (c) , I.P.L. Png & D.E. Lehman Outline  perfect competition  market equilibrium  supply shift  demand shift  adjustment time

11 (c) , I.P.L. Png & D.E. Lehman Market equilibrium  Definition: Price at which quantity demanded equals quantity supplied  When market out of equilibrium, market forces push price towards equilibrium

Market equilibrium

13 (c) , I.P.L. Png & D.E. Lehman Market equilibrium  Excess supply = excess of quantity supplied over quantity demanded  triggers price decrease  Excess demand = excess of quantity demanded over quantity supplied  triggers price increase

14 (c) , I.P.L. Png & D.E. Lehman Outline  perfect competition  market equilibrium  supply shift  demand shift  adjustment time

15 (c) , I.P.L. Png & D.E. Lehman Supply shift  Supply shifts down (right)  new equilibrium with lower price and larger quantity  Supply shifts up (left)  new equilibrium with higher price and smaller quantity  New equilibrium depends on elasticities of demand and supply

Supply shift

Supply shift: Price elasticities of demand and supply

18 (c) , I.P.L. Png & D.E. Lehman Supply shift: Price impact  Price change no more than dollar amount of the supply shift  Price change  smaller if demand is more elastic than supply  larger if supply is more elastic than demand

Foie gras vis-à- vis butter  If Euro becomes 10% more expensive, compare effect on prices of  foie gras  French butter

Promoting retail sales  Wholesale price cut  Consumer coupons

21 (c) , I.P.L. Png & D.E. Lehman Outline  perfect competition  market equilibrium  supply shift  demand shift  adjustment time

22 (c) , I.P.L. Png & D.E. Lehman Demand shift  Demand shifts down (right)  new equilibrium with lower price and lower quantity  Demand shifts up (left)  new equilibrium with higher price and larger quantity  New equilibrium depends on elasticities of demand and supply

Demand shift

24 (c) , I.P.L. Png & D.E. Lehman Tanker services, 2005  Increasing oil prices  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

25 (c) , I.P.L. Png & D.E. Lehman Valentine’s Day  Nearing Valentine’s Day, price of roses always rises much more than the price of greeting cards. Why?

26 (c) , I.P.L. Png & D.E. Lehman Outline  perfect competition  market equilibrium  supply shift  demand shift  adjustment time

Market and individual equilibrium

28 (c) , I.P.L. Png & D.E. Lehman Adjustment time  Short run demand + supply  short run equilibrium  Long run demand + supply  long run equilibrium

Demand increase: Short-run market equilibrium

Demand increase: Long-run market equilibrium

Demand increase

Demand reduction

33 (c) , I.P.L. Png & D.E. Lehman Short vis-à-vis long-run impact  If demand/supply shifts,  Market price is more volatile in the short run than long run  Market quantity is more flexible over the long run than short run

34 (c) , I.P.L. Png & D.E. Lehman Summary  perfect competition  market equilibrium  supply shift  demand shift  adjustment time

35 (c) , I.P.L. Png & D.E. Lehman Numerical example  Suppose  Demand equation is  D=30-0.1p  Supply equation is S=4+0.05p-f  Question: what is the market equilibrium price and quantity?

36 (c) , I.P.L. Png & D.E. Lehman  Answer:  In equilibrium, D=S  Therefore,  p=4+0.05p-f  If f=4 Then p=200  So, D=S=30-0.1*200=10

37 (c) , I.P.L. Png & D.E. Lehman How about supply shift?  S=4+0.05p-f  If there is a decline in the input price, so f drops from 4 to 3.40  Then S=  Question: what is the new equilibrium price and quantity?  D=S  p= p  Therefore, p=196, S=D=10.4