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  • Competitive Markets

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    FrontlineSource: Frontline, Reproduced with permission

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Oil tanker market, 2005Impact ofIncreasing oil pricesIncreasing China importsMore stringent tanker standards

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Outlineperfect competitionmarket equilibriumsupply shiftdemand shiftadjustment time

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Perfect competitionhomogeneous product many buyersmany sellers free entry and exit equal information

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Perfect competitionIn market where products are differentiated, competition is not as keen as that in a market where products are homogeneous.Comparemineral water differentiatedgold pure commodity

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Perfect competitionMany small buyersMany small sellersbuyer/seller with market power can influence demand/supply

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Perfect competitionFree entry and exitNo entry barriers to potential competitorsNo exit barriers to existing sellers

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Perfect competitionMarket with differences in information not as competitive as one where all buyers and sellers have equal informationComparephotocopying servicemedical treatmentlegal advice

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Outlineperfect competitionmarket equilibriumsupply shiftdemand shiftadjustment time

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Market equilibriumDefinition: Price at which quantity demanded equals quantity suppliedWhen market out of equilibrium, market forces push price towards equilibrium

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Market equilibrium

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Market equilibriumExcess supply = excess of quantity supplied over quantity demandedtriggers price decrease Excess demand = excess of quantity demanded over quantity supplied triggers price increase

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Outlineperfect competitionmarket equilibriumsupply shiftdemand shiftadjustment time

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Supply shiftSupply shifts down (right) new equilibrium with lower price and larger quantitySupply shifts up (left) new equilibrium with higher price and smaller quantityNew equilibrium depends on elasticities of demand and supply

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Supply shift

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Supply shift: Price elasticities of demand and supply

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Supply shift: Price impactPrice change no more than dollar amount of the supply shiftPrice change smaller if demand is more elastic than supplylarger if supply is more elastic than demand

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Foie gras vis--vis butterIf Euro becomes 10% more expensive, compare effect on prices offoie gras French butter

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Promoting retail salesWholesale price cutConsumer coupons

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Outlineperfect competitionmarket equilibriumsupply shiftdemand shiftadjustment time

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Demand shiftDemand shifts down (right) new equilibrium with lower price and lower quantityDemand shifts up (left) new equilibrium with higher price and larger quantityNew equilibrium depends on elasticities of demand and supply

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Demand shift

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Tanker services, 2005Increasing oil pricesHigher costs for tanker services supply curve upIncreasing China importsHigher demand for tanker servicesMore stringent tanker standardsNon-complying tankers scrapped supply curve shifted to left

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Valentines DayNearing Valentines Day, price of roses always rises much more than the price of greeting cards. Why?

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Outlineperfect competitionmarket equilibriumsupply shiftdemand shiftadjustment time

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Market and individual equilibrium

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Adjustment timeShort run demand + supplyshort run equilibriumLong run demand + supply long run equilibrium

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Demand increase: Short-run market equilibrium

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Demand increase:Long-run market equilibrium

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Demand increase

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Demand reduction

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Short vis--vis long-run impactIf demand/supply shifts,Market price is more volatile in the short run than long runMarket quantity is more flexible over the long run than short run

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Summaryperfect competitionmarket equilibriumsupply shiftdemand shiftadjustment time

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Numerical exampleSupposeDemand equation isD=30-0.1pSupply equation is S=4+0.05p-fQuestion: what is the market equilibrium price and quantity?

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    Answer:In equilibrium, D=STherefore,30-0.1p=4+0.05p-fIf f=4Then p=200 So, D=S=30-0.1*200=10

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

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    How about supply shift?S=4+0.05p-fIf there is a decline in the input price, so f drops from 4 to 3.40Then S=0.6+0.05Question: what is the new equilibrium price and quantity?D=S30-0.1p=0.6+0.05pTherefore, p=196, S=D=10.4

    (c) 1999-2007, I.P.L. Png & D.E. Lehman

    Basis for managerial economics -- model of competitive markets combines demand with supply in Chapter 6 (Economic Efficiency), show that competitive markets provide desirable outcome benchmark for analyses of market power and imperfect markets

    Demand-supply framework is core of managerial economics --- can address business issues goods and services consumer as well as industrial products domestic and international markets.

    Frontline leading independent tanker owner/operatorTo understand market impact, must consider both demand and supply.The adjective perfect is not intended in a normative sense; more appropriate name for perfect competition would be extreme competition.however, perfect competition, has been universally adopted, hence we follow the established usage.

    Review conditions belowMarket where some buyers have market power different buyers pay different prices; buyers with market power get lower prices; not possible to construct a market demand curve.

    Similarly, where some sellers have market power

    Medical treatment: patients have less information than doctors not all doctors equally informed about current medical technology and regulationsMarket for medical treatment is less competitive.

    Similarly, market for legal advice is less competitive.Very few markets exactly satisfy all five conditions for perfect competition;Nevertheless, model is still useful as frame of reference.

    Market forces tend towards equilibrium: gasoline shortages --> increase in gasoline prices agricultural surpluses --> prices fall labor shortages --> wages rise

    Barriers to market equilibrium government price controls, taxes, and subsidies: will discuss in Chapter 6.Major application of equilibrium model: to predict the impact on price and quantity of changes in demand or supply. First, consider shift in supply, holding demand unchanged.Supply shift lower cost = shift down or to left higher cost = shift up or to right

    Impact of supply shift depends on price elasticity of demand; consider two cases: inelastic demand full price impact, no impact on quantity elastic demand no price impact

    Impact of supply shift also depends on price elasticity of supply; consider two cases: inelastic supply no impact on price or quantity elastic supply full price impact

    On world market, supply of French agriculture products (such as foie gras and butter) depends on the exchange rate between the French franc and world currency; demand for foie gras less elastic so world price of foie gras will rise, but by less than 10% demand for French butter very elastic many substitutes: so world price of French butter wont change

    Assume perfect competition the most competitive possible scenario in retail market;

    Represent wholesale price cut by shifting down the retail supply curve; retail quantity increases to Q retail price drops by less than wholesale price --- drop depends on price elasticities of demand and supply.

    Real reason why retailers absorb part of price cut: retail demand is not completely inelastic.

    Major application of equilibrium model: to predict the impact on price and quantity of changes in demand or supply.

    Now, consider shift in demand, holding supply unchanged.Exercise: work out various scenarios completely elastic supply completely inelastic supplycompletely elastic demand completely inelastic demand

    Consider price elasticities of supply: supply of greeting cards very elastic can be manufactured months in advance and stored supply of roses not so elastic, because item is

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