1. Market Equilibrium and Market Demand: Perfect Competition
Chapter 8

2. Chapter 8 - Topics of Discussion
DERIVATION OF THE MARKET SUPPLY CURVE
Firm Supply Curve -- Own-Price Elasticity of Supply
Market Supply Curve -- Producer Surplus
MARKET EQUILIBRIUM UNDER PERFECT COMPETITION
Market Equilibrium
Total Economic Surplus
Applicability to Policy Analysis
ADJUSTMENTS TO MARKET EQUILIBRIUM
Market Disequilibrium -- Market Shortage
Market Surplus Length of Adjustment Period
Cobweb Adjustment Cycle

3. Firm’s supply curve
starts at shut down
level of output
Page 131

4. Profit maximizing firm
will desire to produce
where MC=MR
Page 131

5. Page 131 Economic losses will occur beyond output OMAX, where
MC > MR
Page 131

6. Building the Market Supply Curve+ =
Market supply curve can be thought of as the horizontal summation
of the supply decisions of all firms in the market. Here, at a price
of $1.50, Gary would supply 2 tons of broccoli and Ima would
supply 1 ton, giving a market supply of 3 tons.
Page 132

7. MARKET SUPPLY SCHEDULE
Quantity
Point Price Supplied A B C D D C B A Q

8. Own-Price elasticity of supply=

9. Calculate own-price elasticity of supply between $2 and $3.
DQ P
DP Q X
DQ = 3, DP = 1, Q = 4.5, P = 2.5

10. DQ P
DP Q X
X = =
ELASTIC
1% DP gives rise to a 1.66% DQ in quantity

11. Concept of Producer Surplus
Producer surplus is a fancy term economists
use for profit. We measure producer surplus
as the area above the supply curve and
below the market equilibrium price.
Page 132

12. Concept of Producer Surplus
Producer surplus is a fancy term economists
use for profit. We measure producer surplus
as the area above the supply curve and
below the market equilibrium price.
Total economic surplus is therefore equal to
consumer surplus discussed in Chapter 4
plus producer surplus.
Page 132

13. Market Price of $4 Page 133 Producer surplus at $4
Product price
Producer surplus at $4
is equal to area ABC F G
Page 133

14. Page 133 Total revenue at $4 would be area 0ABF while total cost
would be area 0CBF. Thus
Profit = area 0ABF-area 0CBF
Product price C F G
Page 133

15. by multiplying price time quantity, or $4 times output F
Total revenue at $4 would be
area 0ABF while total cost
would be area 0CBF. Thus
Profit = area 0ABF-area 0CBF
Product price
Area 0ABF can be found
by multiplying price time
quantity, or $4 times output F C F G
Page 133

16. Suppose Price Increased to $6
Product price
Producer surplus at $6
is equal to area EDC F G
Page 133

17. Page 133 Total revenue at $6 would be area 0EDG while total cost
would be area 0CDG. Thus
profit would be area 0EDG
minus area 0CDG, or CED.
Product price C F G
Page 133

18. The gain in producer surplus if the price increases from $4
is equal to area AEDB
Producers are better
off economically by
responding to this
price increase by
producing output G C F G
Page 133

20. Some Important Jargon We need to distinguish between movement
along a demand or supply curve, and shifts
in the demand or supply curve.

21. Some Important Jargon We need to distinguish between movement
along a demand or supply curve, and shifts
in the demand or supply curve.
Movement along a curve is referred to as a
“change in the quantity demanded or supply”.
A shift in a curve is referred to as a “change
in demand or supply”.

22. Page 135 Increase in demand pulls up price from Pe to Pe*
Decrease in demand
pushes price down
from Pe to Pe*
Page 135

23. Page 135 Decrease in supply Increase in supply pulls up price from
pushed price down
from Pe to Pe*
Decrease in supply
pulls up price from
Pe to Pe*
Page 135

24. Economic Welfare Concepts
We can use the concepts of market demand
and supply to assess the effects of events
in the economy have upon the economic
well being of consumers and products in
a particular market.
We assess these effects using the concept of
Consumer surplus introduced in Chapter 4 with
producer surplus discussed here.

25. ECONOMIC SURPLUS
Economic Surplus = Consumer Surplus + Producer Surplus
Consumer Surplus = area #1, Producer Surplus = area #2

26. An Example of Economic Welfare Analysis
Assume a drought occurs
that results in a decrease
in supply from S to S*.
Before this happened,
consumer surplus was
area while producer
surplus was equal to
area 6+7.
Page 137

27. An Example of Economic Welfare Analysis
After the decrease in
supply, consumer surplus
is just area 3. They lose
area 4 and area 5.
Producers gain area 4 but
lose area 7.
Page 137

28. An Example of Economic Welfare Analysis
Consumers are therefore
worse off because of the
drought.
Producers are also worse
off if area 4 is less than
area 7.
Society loses area 5+7.
Page 137

29. CHANGE IN ECONOMIC SURPLUS

30. Measuring Surplus Levels$7 D
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15 S $4
Product price $1 10

31. Measuring Surplus Levels$7 D
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15 S $4
Product price
Producer surplus is
Equal to (10 x (4-1))÷2,
or $15 $1 10

32. Measuring Surplus Levels$7 D
Consumer surplus is
equal to (10 x (7-4))÷2,
or $15 S $4
Product price
Producer surplus is
Equal to (10 x (4-1))÷2,
or $15 $1 10
Total economic surplus
is therefore $30…

33. Market Disequilibrium

34. Market Surplus Page 138 If the price is PS, producers would
supply QS while
consumers would
only want QD at
this high price.
Page 138

35. Market Shortage Page 138 If the price is PD, producers would
only supply QD
while consumers
want QD at this
low price.
Page 138

36. Adjustments to Market Equilibrium
Markets converge to equilibrium over time
unless other events in the economy occur.
One explanation for this adjustment which
makes sense in agriculture is the Cobweb
theory. This name stems from the spider
like trail the adjustment process makes.

37. Year Two Reactions Page 140 Producers use last year’s
price as their expected
price for year 2.
Consumers on the other
hand pay this year’s
price determined by Q2.
Page 140

38. Year Three Reactions Page 140 Producers now decide to
produce less at the lower
expected price. This
lower quantity pushes
price up to P3 in year 3.
Page 140

39. Cobweb Pattern Over Time
Market
equilibrium
The market converges to
market equilibrium where
demand intersects supply
at price PE. In some
markets, this adjustment
period may only be months
or even weeks rather than
years assumed here.
Page 140