Competitive Markets

Frontline

Source: Frontline, Reproduced with permission

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Oil tanker market, 2005

Impact of Increasing oil prices Increasing China imports More stringent tanker standards

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Outline

perfect competition market equilibrium supply shift demand shift adjustment time

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Perfect competition

homogeneous product many buyers many sellers free entry and exit equal information

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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

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Perfect competition

Many small buyers Many small sellers

buyer/seller with market power can influence demand/supply

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Perfect competition

Free entry and exit No entry barriers to potential

competitors No exit barriers to existing sellers

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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

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Outline

perfect competition market equilibrium supply shift demand shift adjustment time

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Market equilibrium

Definition: Price at which quantity demanded equals quantity supplied

When market out of equilibrium, market forces push price towards equilibrium

Market equilibrium

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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

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Outline

perfect competition market equilibrium supply shift demand shift adjustment time

15(c) 1999-2007, 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

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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

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Outline

perfect competition market equilibrium supply shift demand shift adjustment time

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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

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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

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Valentine’s Day

Nearing Valentine’s Day, price of roses always rises much more than the price of greeting cards. Why?

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Outline

perfect competition market equilibrium supply shift demand shift adjustment time

Market and individual equilibrium

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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

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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

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Summary

perfect competition market equilibrium supply shift demand shift adjustment time

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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?

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Answer: In equilibrium, D=S Therefore, 30-0.1p=4+0.05p-f If f=4

Then p=200 So, D=S=30-0.1*200=10

37(c) 1999-2007, 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=0.6+0.05 Question: what is the new equilibrium

price and quantity? D=S30-0.1p=0.6+0.05p Therefore, p=196, S=D=10.4