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

2. Discussion Topics Derivation of market supply curve
Elasticity of supply and producer surplus
Market equilibrium under perfect competition
Total economic surplus
Adjustments to market equilibrium 2

3. Remember the firm’s supply curve?
P=MR=AR 3
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4. Firm’s supply curve starts at shut down output level Where MR < AVC
Profit maximizing firm will desire to produce where MC=MR
P3=MR3=AR3
P2=MR2=AR2
P1=MR1=AR1
Firm’s supply curve starts at shut down output level
Where MR < AVC
Economic losses occur
where MC > MR
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5. Building the Industry Supply Curve
Market supply curve: The horizontal summation of the supply decisions of all firms in the market
At a price of $1.50, Gary would supply 2 tons of broccoli 5
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6. Building the Industry Supply Curve
Market supply curve: The horizontal summation of the supply decisions of all firms in the market
At a price of $1.50, Ima would supply 1 ton of broccoli 6
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7. Building the Industry Supply Curve
Market supply curve: The horizontal summation of the supply decisions of all firms in the market
At a price of $1.50 market supply would be 3 tons 7
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8. Determining Market Equilibrium
With the above we have identified the Market Supply Curve
Previously we derived the Market Demand Curve
Horizontal summation of individual demand curves
We can combine these concepts to identify what is referred to as the Market Equilibrium 8

9. Determining Market Equilibrium
Market Supply Curve =
Horizontal summation of
individual firm supply curves D S
Price PE
Market clearing price
Quantity QE
Market Demand Curve =
Horizontal summation of
individual consumer demand curves 9

10. Determining Market Equilibrium
Price D S PE
Chapters 3 - 5
Quantity QE 10

11. Determining Market Equilibrium
Factors that change (shift) demand:
Prices of other goods
Consumer income
Tastes and preferences
Real wealth effect
Global events
Price D* D S
PE* PE
Quantity QE
QE* 11

12. Determining Market Equilibrium
Price D S
Chapters 6 - 7 PE
Quantity QE 12

13. Determining Market Equilibrium
Factors that change (shift) supply:
Input costs
Government policy
Price expectations
Weather & disease
Global events S*
Price D S
PE* PE
Quantity
QE* QE 13

14. Concept of Producer Surplus
Producer Surplus (PS) is a term economists use for aggregate returns over total variable costs
PS measured as the area above the supply curve and below market equilibrium price
Remember the supply curve is determined by individual MC curves 14
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15. Concept of Producer Surplus
Market Price of $4
Price
Market Supply
Total Revenue = 0ABD A B $4
Product Price
Total Variable Cost = 0CBD C
Output D 15
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16. Concept of Producer Surplus
Market Price of $4
Price
Market Supply A B $4
Product Price
PS at $4 = area ABC C
Output D 16
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17. Concept of Producer Surplus
Suppose Price Increased to $6…
Price
Market Supply E F $6 A B $4
PS at $6 = area EFC C
Output D G 17
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18. Concept of Producer Surplus
The gain in PS if the price increases from $4 to $6 is equal to area AEFB
Price
Market Supply E F $6
Producers are better off by increasing output from D to G A $4 B C
Output D G 18
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19. Assessing Economic Welfare
We can use the concepts of market demand and supply to
Assess the effects of events in the economy on the economic well being of consumers and producers
For a particular market
During a specific time period
We do this using the concept of total economic surplus (TES) defined as:
TES = CS + PS
Total Surplus
Consumer Surplus
Producer Surplus 19

20. Assessing Economic Welfare$ E
An Example of Economic Welfare Analysis S
Assume we have a market
PS = area BCE
CS = area BCA
TES = area BCA + area BCE = area AEC
Then a drought occurs
How can we examine whether consumers or producers are impacted B C A D Q 20
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21. Assessing Economic Welfare$
An Example of Economic Welfare Analysis E S* S
Assume the drought causes supply curve to shift up
After the drought
PS = area HFI
Gain BFIC + Lose AHGC
CS = area FEI
Lose BFIG + Lose GIC
TES = area HEI
Lose AHGC + Lose GIC I F B C G H A D Q 21
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22. Assessing Economic Welfare$
An Example of Economic Welfare Analysis E S* S
Drought causes
Consumers to be worse off as no gain area
Producers are worse off if area BFIG (gain) is less than AHGC (loss)
Area BFIG is transferred from consumers to producers
Society is on net worse off as no gain area (area AHIC) I F B C G H A D Q 22
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23. Assessing Economic Welfare
Measuring Surplus Levels $
ABCD = ?
FADE = ?
Supply B C $6
CS = (10 x (6-4))÷2 = $10 D A $4
Product price
PS =(10 x (4-1))÷2 = $15
Demand $1 E F Q 10
→Total economic surplus = CS + PS
= $10 + $15 = $25 23
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24. Modeling Commodity Prices24

25. Modeling Commodity Prices
Forecasting Future Commodity Price Trends $
D = α – βP + γYD + δX S $6
Own
price
Disposable
income
Other
factors $4
Own
price
Input
costs
Other
factors D $1 Q 10
S = θ + πP – τC + χZ 25
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26. Modeling Commodity Prices$ S
QD = 10 – 6P + .3YD + 1.2X
Equilibrium
Condition P*
Q* =QD = QS
QD = QS D
QS = 2 + 4P – .2C Z Q Q*
How can we determine the values of P* and Q*? 26
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27. Modeling Commodity Prices$ S
QD = 10 – 6P + .3YD + 1.2X
Equilibrium
Condition P*
Q* =QD = QS
QD = QS D
QS = 2 + 4P – .2C Z Q Q*
The above shows relationship between P and either QS and/or QD
Lets undertake a ceteris paribus analysis and assume values for YD, X C and Z 27
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28. Modeling Commodity Prices$ S
QD = 50 – 6P
Equilibrium
Condition P*
Q* =QD = QS
QD = QS D
QS = P Q Q*
How can we determine the value of Q*
Substitute demand and supply equations into equilibrium condition
Solve for equilibrium price (P*)
Substitute this price into either supply or demand equation for Q* 28
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29. Modeling Commodity Prices
How can we determine the value of Q* and P*
Substitute demand and supply equations into equilibrium condition
Solve for equilibrium price (P*)
50 – 6P = P → P = 0
→P* = 8/10 = 0.80
Substitute this price into either supply or demand equation for Q*
Demand Equation
QD* = 50 – 6P* = 50 – 6(0.8) = 50 – 4.8 = 45.2
Supply Equation
QS* = P* = (0.8) = = 45.2
Q* =QD = QS→ (50 – 6P) = (42 + 4P) 29
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30. Many Applications Policy decisions by Congress and the President
Commodity modeling by brokers/traders
Lender credit repayment capacity analysis
Outlook presentations by extension eco.
Farm planting decisions
Livestock producers herd size and feedlot placement decisions
Strategic planning for processors 30

31. Market Disequilibrium31

32. Market Disequilibrium
At PS→ Market Surplus exists as QS – QD > 0
Surplus S PS
At price PS, consumers would demand QD
At price PS, producers would supply QS P* PD D QD Q* QS 32
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33. Market Disequilibrium
At PD→ Market Shortage exists as QS – QD < 0 S PS
At price PD, producers would supply QD
At price PD, consumers would demand QS P* PD D QD Q* QS
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Shortage

34. Market Disequilibrium
Markets converge to equilibrium over time unless other events in the economy occur
One explanation for this adjustment which makes sense for agriculture is the Cobweb theory
This names comes from the spider web-like trail the adjustment process makes 34

35. Market Disequilibrium
Lets use the example of a grain producer
Producers tend to use last year’s price (P1) as their expected price for this year (year 2)
In contrast, consumer’s pay this years price (P2) determined by market equilibrium Q2 35

36. Market Disequilibrium
Year Two Reactions 36
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37. Market Disequilibrium
Year Three Reactions P3 P2
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38. Market Disequilibrium
Year Four Reactions
Producer decision
based on Year 3 Price P3 P4
Consumer decision
based on Year 4 Price Q4 38
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39. Market Disequilibrium
From the above results we have the following:
(P1 – P2) > (P3 – P2) > (P3 – P4)
(Q2 – Q1) > (Q2 – Q3) > (Q4 – Q3)
Eventually wil converge to P*, Q* the equilibrium price and quantity
Price changes are getting smaller
Quantity changes are getting smaller
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40. Market Disequilibrium
Cobweb Pattern Over Time
The market converges to an equilibrium price and quantity
QD = QS at PE
In some markets, adjustment period may months, weeks or years
Depends on production time required
Market
equilibrium 40
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41. Market-to-Firm Linkages41

42. Some Important Jargon As we noted before we distinguish between
Movement along a particular demand or supply curve
Referred to as a change in quantity demanded or supplied
Shifts in the demand or supply curve
Referred to as a change in demand or supply 42

43. Increase in demand increases price from Pe to Pe* Decrease in demand
decreases price from Pe to Pe*
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44. Increase in supply decreases price from Pe to Pe* Decrease in supply
increases price from
Pe to Pe*
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45. Merging Demand and Supply
Price D S
Chapters 6-7 PE
Chapters 3-5
Quantity QE 45

46. Firm is a Price Taker Under Perfect Competition
The Market
The Firm
Price
Price D S
PE= MR = MC
AVC MC PE QE QF
Quantity 46

47. Impact of an Increase in Demand
The Market
The Firm
Price D1
Price D S MC
AVC PE QE
Q*E
10 11
Quantity 47

48. Impact of a Decrease in Demand
The Market
The Firm
Price
Price D S D2
AVC MC PE
Q*E QE
9 10
Quantity 48

49. Firm is a Price Taker in the Input Market
Wage
Rate
Labor Market
Wage
Rate
The Firm DL SL
MVP
MIC PL QL LF
Labor 49

50. Firm is a Price Taker in the Input Market
Wage
Rate
Labor Market
The Firm
Wage
Rate
DL* SL DL
MVP PL
MIC QL
L*F LF
Labor 50

51. Effects of Increasing The Minimum Wage
Rate
Labor Market
Wage
Rate
The Firm D S
MVP
PMIN
MIC QD QS
LMAX
Labor 51

52. Summary
Market equilibrium price and quantity are given by the intersection of demand and supply
Producer surplus captures the profit earned in the market by producers
Total economic surplus is equal to producer surplus plus consumer surplus
A market surplus exists when the quantity supplied exceeds the quantity demanded.
A market shortage exists when the quantity demanded exceeds the quantity supplied. 52

53. Chapter 9 focuses on market equilibrium and product prices under conditions of imperfect competition…. 53