Unit 8 - Supply and demand - 1.0
Unit 8: Supply and Demand: Price-Taking and Competitive Markets
Page 4: Context for This Unit
Firms with market power can set their own prices; market outcomes are often not Pareto-efficient.
Differences between price-setting firms and price-taking firms:
Behavior variations.
Competition potential to improve market outcomes (see Unit 7).
Page 5: This Unit
Focus on the model of interaction between price-taking firms and consumers.
Perfect competition examined as a specific model case.
Analysis of similarities and differences between price-taking and price-setting firms.
Page 6: Competitive Equilibrium: Key Concepts
Page 7: Demand Curve
Definition: Total quantity desired by consumers at various prices.
Represents buyers' willingness to pay (WTP).
Example: Secondhand textbook market illustrates this concept.
Page 8: Supply Curve
Definition: Total quantity that firms produce at various prices.
Represents sellers' willingness to accept (WTA).
Different sellers may have varying reservation prices.
Page 9: Equilibrium Price
Definition: A price point where supply equals demand (market-clearing).
Non-equilibrium prices lead to excess supply or demand, deviating from Nash equilibrium.
Example: Price above equilibrium (P*) results in excess supply; sellers can benefit from reducing price.
Page 10: Price-Taking Firms
Demand curve appears flat for price-takers.
Profit maximization occurs at MR = P = MC (Marginal Cost).
Firm's supply curve corresponds to the MC curve.
Price-taking firms cannot influence market prices; they select quantity.
Page 11: Market Supply Curve
Represents total production by all firms at each price level.
If firms share identical cost functions, the market supply curve is equivalent to the market's marginal cost curve.
Page 12: Competitive Equilibrium
Condition where all buyers and sellers act as price-takers.
At prevailing market price, supply equals demand.
Page 13: Characteristics of Competitive Equilibrium
Total trade gains are fully optimized (no deadweight loss).
Allocated resources are Pareto efficient under the following assumptions:
All participants are price-takers.
Contracts are comprehensive.
Transactions solely affect involved buyers and sellers (no external factors).
Page 14: Caveats of Competitive Equilibrium
Pareto efficiency may not be achieved if initial assumptions are violated.
Distribution of total surplus influenced by demand and supply elasticities:
The share of total surplus inversely relates to elasticity.
Real-life scenarios rarely identify true price-takers.
Page 15: Factors Affecting Equilibrium
Page 16: Changes in Supply and Demand
Buyer and seller behaviors adapt to market conditions leading to clearance.
Example: Improved bread baking technology causes an increase in supply, shifting the supply curve.
Results in excess supply at current market price.
Prices continue falling until a new equilibrium price is reached.
Page 17: Market Entry
If existing firms reap economic profits and entry costs are manageable, new firms may enter the market.
Market supply curve adjustments can occur due to firm entrance or exit.
Page 18: Taxes
Taxes on suppliers and consumers shift supply and demand curves upward; price increases at each quantity.
Impact on surplus:
Consumer surplus marked in red, producer surplus in purple, government revenue in green, with deadweight loss illustrated as a white triangle.
Taxes have historically been utilized for government revenue generation.
Page 19: Taxes: Welfare Effects
Total surplus reduction positively correlates with demand elasticity.
Tax incidence is determined by relative elasticity—less elastic groups shoulder more tax burden.
Tax revenues can facilitate elevated welfare if utilized for public benefits.
Page 20: Example: Denmark’s Butter Tax
Consumption of butter decreased by 15-20% post-tax implementation.
The tax, initially targeting saturated fat, faced removal due to collection burdens.
Page 21: Perfect Competition
Page 22: Definition of Perfect Competition
Characteristics include:
Homogeneous goods/services
Numerous potential buyers and sellers
Independent behavior among participants
Availability of price information for buyers and sellers.
Page 23: Characteristics of Perfect Competition
Law of One Price: All transactions transact at a unified price.
Market equilibrium is achieved at this price (supply = demand).
All buyers and sellers partake as price-takers, realizing all trade gains.
While perfect competition may not be fully realizable, it approximates real market behavior effectively.
Page 24: Evidence of Perfect Competition
Economists evaluate two competitive equilibrium tests:
Do all trades occur at a uniform price?
Are entities pricing goods at equal to marginal cost?
Difficulties arise in pinpointing true examples; price variances exist even when price-checking is simplified (e.g., online shopping).
Page 25: Price-Setters vs. Price-Takers
Price-setters (Monopoly) versus Price-takers (Perfect Competition):
Price-setters operate with MC < Price; may incur deadweight losses and result in Pareto inefficiency.
Price-takers realize no deadweight loss, achieving potential Pareto efficiency.
Unlike price-setters, price-takers incur no economic rents in the long run and demonstrate minimal advertisements.
Page 26: Summary
Model of price-taking firms showcases competitive equilibrium where demand meets supply.
Firms optimize profits when MC equals price.
Perfect competition serves as a special case demonstrated against pricing-setter models.
Illustrated how equilibrium alters due to exogenous demand/supply shifts or market entry, emphasizing tax impact on surplus.
Page 27: Next Unit
Examination of the labor market differing from goods markets concerning wage, employment, and income distribution dynamics.
Analysis of supply and demand fluctuations due to unions and public policy implications on wages and employment.