MARKETIMBA Managerial Economics

Jack Wu

COMPETITIVE MARKETS

OIL TANKER MARKET, 2005

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

PERFECT COMPETITION homogeneous product many buyers many sellers price takers free entry and exit equal information

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

PERFECT COMPETITION

Many small buyers Many small sellers

buyer/seller with market power can influence demand/supply

PERFECT COMPETITION

Free entry and exit No entry barriers to potential competitors No exit barriers to existing sellers

FREE ENTRY?

Japanese Beer Market, pre-’94:

Ministry of Finance production licenses for minimum of 2 million

liters a year sales licenses limited to small family-owned

stores

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

MARKET EQUILIBRIUM, I

Price at which quantity demanded equals quantity supplied when market out of equilibrium, market forces push price towards equilibrium

0

20

22

8 10 11

supply

demand

a

b

c

equilibrium

excess supply

Quantity (Million ton-miles a year)

Pri

ce (

$ p

er

ton

-mil

e)

MARKET EQUILIBRIUM, II

MARKET EQUILIBRIUM, III

excess supply = excess of quantity supplied over quantity demanded triggers price decrease

excess demand = excess of qty demanded over qty supplied triggers price increase

SUPPLY SHIFT, I

supply shifts down (right) -> lower price, larger quantity

supply shifts up (left) -> higher price, smaller quantity

final equilibrium depends on elasticities of demand and supply

0

19.60

20

10 10.4

original supply

new supply

demand60 cents

60 cents

c e

b

d

Quantity (Million ton-miles a year)

Pri

ce (

$ p

er

ton

-mil

e)

a

SUPPLY SHIFT, II

0 10

19.40

20

original supply

new supply

demand

60 cents

60 centsc

b

0 10 10.6

20 new supply

original supply

demand

60 cents

60 centsb

c

Extremely inelastic demand Extremely elastic demand

Quantity (Million ton-miles a year) Quantity (Million ton-miles a year)

Pri

ce (

$ p

er

ton

-mil

e)

Pri

ce (

$ p

er

ton

-mil

e)

e e

PRICE ELASTICITIES OF DEMAND

0

20

10

demand

a

b

original and new supply

0 10 11

19.40

20 60 cents 60 cents

a

b original supply

new supply

demand

Pri

ce (

$ p

er

ton

-mil

e)

Pri

ce (

$ p

er

ton

-mil

e)

Quantity (Million ton-miles a year) Quantity (Million ton-miles a year)

Extremely inelastic supply Extremely elastic supply

PRICE ELASTICITIES OF SUPPLY

SUPPLY SHIFT: PRICE IMPACT

price change no more than amount of the supply shift

price change smaller if demand is more elastic than supply larger if supply is more elastic than demand

0

1.50

1

retail supply

a

Quantity (Million units a year)

Pri

ce (

$ p

er

unit

)

after wholesale price cut

retail demand

b

PROMOTING RETAIL SALES

Q

DEMAND SHIFT, I

demand shifts down (left) -> lower price, lower quantity

demand shifts up (right) -> higher price, larger quantity

final equilibrium depends on elasticities of demand and supply

0

20

10 10.8

supply

new demand

original demand

1 million

af

b

c

1 million

Quantity (Million ton-miles a year)

Pri

ce (

$ p

er

ton

-mil

e)

DEMAND SHIFT, II

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

VALENTINE’S DAY

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

CALCULATING EQUILIBRIUM, I

How would 3% increase in income affect price and sales of gasoline? demand

price elasticity -.23 income elasticity 0.39

supply price elasticity 0.62

CALCULATING EQUILIBRIUM, II

1. % change in qty demanded = -0.23 %p + 0.39 x 3

2. % change in qty supplied = 0.62 %p3. equate and solve: %p = 1.38%4. % change in qty = 0.87%

0

20

22

100105

price

short-runaveragevariable cost

short-runmarginal cost

Quantity (Thousand ton-miles a year) Quantity (Thousand ton-miles a year)

0

20

22

10

12

short-rundemand

short-runsupply

1 million

a

c

Pri

ce (

$p

er

ton

-mile)

Pri

ce (

$ p

er

ton

-mil

e)

(a) Individual seller (b) Market

SHORT-RUN MARKET EQUILIBRIUM

0

2021

100

original long-run averagecost

new long-runaverage cost

long-runmarginal cost

Quantity (Thousand ton-miles a year) Quantity (Thousand ton-miles a year)

0

2021

10

13

long-rundemand

long-runsupply1 million

a

d

Pri

ce (

$p

er

ton

-mile)

Pri

ce (

$ p

er

ton

-mil

e)

(a) Individual seller (b) Market

LONG-RUN MARKET EQUILIBRIUM

SHORT/LONG-RUN IMPACT

If demand/supply shifts, market price is more volatile in the short run

than long run greater change in market quantity over the

long run than short run

DEMAND INCREASE

DEMAND REDUCTION

PRICING AND FREIGHT COST, I

cost and freight ex-works pricing

How does pricing policy affect sales?

0

1.50

1

CF supply

a

Quantity (Million pounds a year)

Pri

ce (

$ p

er

pou

nd

)

ex-works supply

CF demand

ex-works demand

b

25 cents

25 cents

PRICING AND FREIGHT COST, II

RETAILING: WHY COUPONS?

alternative -- cutting wholesale prices “With coupons, prevent retailers from getting

part of price cut.”

DISCUSSION QUESTION

Industry researchers R.S. Platou predicted that, between 2003 and 2004, oil prices would fall by 5%, production of oil by OPEC and the former Soviet Union would increase, and deliveries of new tankers would exceed scrappage of older vessels.

DISCUSSION QUESTION

(a)Uisng suitable diagrams, explain how each of the following would affect the market for tanker services: (i) fall in oil prices; (ii) increase in production by OPEC and the former Soviet Union; (iii) new tanker deliveries; and (iv) scrappage of older vessels.

(b)Suppose that the net effect is to increase tanker rates. Illustrate the net effect on a single diagram. Explain the impact on the quantity of tanker services used.