Competition in markets
• Compared to last week, now there are many
firms, each of which has little size.
Key Concepts
• Market supply.
• Equilibrium.
• Total surplus = Consumer + producer surplus.
• Efficiency and deadweight loss.
• Shocks to supply and demand.
• Taxation and other interventions in markets.
Firms in competitive market – supply
• You face a Price from competitors, you cannot change.
• Remember profit maximization.
• What is for you now f’(Q)?
• Hence C’(Q) = ?
Firms in competitive market – supply
• Hence C’(Q) = P, so by just changing P we get all the Q’s
• That is the supply curve for a firm, but for negative profits.
Equilibrium
• A Price. Quantity pair where supply = demand.
• Equilibration – prices where supply and demand do
not match, will lead to changes. You SAW!
• But let us think: good is identical, all have the
information.
• Then, just one Price should hold – sellers would want
no lower and buyers would not accept it – Law of one
Price.
• This can only be Price where supply = demand.
• Why?
Equilibrium and market price
• Q = 40 – 2P – Demand
• Q = 4P – 8 – Supply
• Equilibrium ?
When is equilibrium likely to hold?
• Main assumption – individual are Price-takers.
• Many buyers, many sellers, and good information.
Price Transactions
0 1
1 2
2 2
3 3
4 12
5 11
5.5 14
6 2
7 1
7,5 1
8 5
9 3
10 0
Average price 2015 = 5.2 Average price 2014 = 5.33
Standard dev. 2015 = 0.75 Standard dev. 2014 = 0.53
Below, V. Smith’s experiments
The analytics of equilibrium
• In general which will have just one
solution if supply is increasing and demand decreasing.
• With linear demand and supply:
• Where a, b, c, and d are all positive constants.
• a > c, when that not true, equilibrium is Q = 0. Why?
• Equilibrium
• Hence
Efficiency and surplus
• Consumer surplus: sum of WTP – sum of prices paid.
• Producer surplus: sum of prices paid – sum of MgC
• Producer surplus relationship to profits?
• Total surplus: sum of WTP – sum of MgC
• CS = ; PS =
Efficiency and surplus
• Maximized at competitive equilibrium.
• Price is such that WTP ≥ MgC for all units sold. None
can be excluded. For units excluded WTP < MgC
producing them would lower surplus.
Remember the evil monopolist
• Approx DWL:
• Could you ever justify this loss of welfare?
Shocks to supply and demand: Linear case
• In linear case we have:
• Thus a shock to demand, change in “a” leads to, P and
Q change in same direction:
• A shock to supply:
• A change in c has same effect on P as a change in –a.
• This is because Price only depends on (a – c).
• This can also be done for the non-linear case (similar).
The same outcomes graphically
Market entry
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
0 2,000 4,000 6,000 8,000 10,000
Price, €
Quantity: number of loaves
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
0 40 80 120 160 200 Price, Cost, €
Quantity: number of loaves
New
supply
(MC)
Original
supply
(MC)
Demand
A
Marginal cost
curve
Isoprofit
curve: €200
Isoprofit
curve: €80
Zero economic
profit (AC curve)
B
C
A
B
C
Longrun
supply
(MC)
Intervention in markets: taxes on producers
Tax and surplus división/loss
Tax, elasticity and deadweight loss
Tax incidence and elasticity
Unit 7 vs. Unit 8