Agri 2312 chapter 8 market equilibrium and product price

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AGRICULTURAL ECONOMICS

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Agri 2312 chapter 8 market equilibrium and product price

  1. 1. Market Equilibrium and Market Demand: Perfect Competition Chapter 8
  2. 2. Discussion Topics <ul><li>Derivation of market supply curve </li></ul><ul><li>Elasticity of supply and producer surplus </li></ul><ul><li>Market equilibrium under perfect competition </li></ul><ul><li>Total economic surplus </li></ul><ul><li>Adjustments to market equilibrium </li></ul>
  3. 3. Page 131 P=MR=AR Remember the firm’s supply curve?
  4. 4. Page 131 Firm’s supply curve starts at shut down level of output P=MR=AR
  5. 5. Page 131 Profit maximizing firm will desire to produce where MC=MR P=MR=AR
  6. 6. Page 131 Economic losses will occur beyond output O MAX , where MC > MR P=MR=AR
  7. 7. Market supply curve can be thought of as the horizontal summation of the supply decisions of all firms in the market. Here, at a price of $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons. Page 132 Building the Market Supply Curve
  8. 8. Market supply curve can be thought of as the horizontal summation of the supply decisions of all firms in the market. Here, at a price of $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons. + Page 132 Building the Market Supply Curve
  9. 9. Market supply curve can be thought of as the horizontal summation of the supply decisions of all firms in the market. Here, at a price of $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons. + = Page 132 Building the Market Supply Curve
  10. 10. Merging Demand and Supply Price Quantity D S P E Q E Market clearing price
  11. 11. Merging Demand and Supply Price Quantity D S P E Q E Chapters 3-5
  12. 12. Merging Demand and Supply Price Quantity D S P E Q E <ul><li>Factors that change </li></ul><ul><li>demand: </li></ul><ul><li>Other prices </li></ul><ul><li>Consumer income </li></ul><ul><li>Tastes and preferences </li></ul><ul><li>Real wealth effect </li></ul><ul><li>Global events </li></ul>D* Q E* P E*
  13. 13. Merging Demand and Supply Price Quantity D S P E Q E Chapters 6-7
  14. 14. Merging Demand and Supply Price Quantity D S P E Q E <ul><li>Factors that change </li></ul><ul><li>supply: </li></ul><ul><li>Input costs </li></ul><ul><li>Government policy </li></ul><ul><li>Price expectations </li></ul><ul><li>Weather & disease </li></ul><ul><li>Global events </li></ul>Q E* P E* S*
  15. 15. Concept of Producer Surplus Producer surplus is a fancy term economists use for profit . We measure producer surplus as the area above the supply curve and below the market equilibrium price. Page 133
  16. 16. Concept of Producer Surplus Producer surplus is a fancy term economists use for profit. We measure producer surplus as the area above the supply curve and below the market equilibrium price. Total economic surplus is therefore equal to consumer surplus discussed in Chapter 4 plus producer surplus. Page 133
  17. 17. Page 133 F G Product price Market Price of $4 A B Producer surplus at $4 is equal to area ABC
  18. 18. Page 133 F G Producer surplus at $6 is equal to area EDC Product price Suppose Price Increased to $6…
  19. 19. Page 133 The gain in producer surplus if the price increases from $4 is equal to area AEDB F G Producers are better off economically by responding to this price increase by producing output G C
  20. 20. Economic Welfare Concepts We can use the concepts of market demand and supply to assess the effects of events in the economy have upon the economic well being of consumers and products in a particular market during a specific period. We do this using the total economic surplus which is given by: Total economic Consumer Producer surplus surplus surplus = +
  21. 21. An Example of Economic Welfare Analysis Page 136-137 Assume a drought occurs that results in a decrease in supply from S to S*. Before this happened, consumer surplus was area 3+4+5 while producer surplus was equal to area 6+7. Total economic equals area 3+4+5+6+7
  22. 22. An Example of Economic Welfare Analysis After the decrease in supply, consumer surplus is just area 3. They lose area 4 and area 5. Producers gain area 4 but lose area 7. Page 136-137
  23. 23. An Example of Economic Welfare Analysis Consumers are therefore worse off because of the drought. Producers are also worse off if area 4 is less than area 7. Society loses area 5+7. Page 136-137
  24. 24. Measuring Surplus Levels Product price D S $4 10 $1 $7 Consumer surplus is equal to (10 x (7-4)) ÷2, or $15 Page 136-137
  25. 25. Measuring Surplus Levels Product price D S $4 10 $1 $7 Consumer surplus is equal to (10 x (7-4)) ÷2, or $15 Producer surplus is Equal to (10 x (4-1)) ÷2, or $15 Page 136-137
  26. 26. Measuring Surplus Levels Product price D S $4 10 $1 $7 Consumer surplus is equal to (10 x (7-4)) ÷2, or $15 Producer surplus is Equal to (10 x (4-1)) ÷2, or $15 Total economic surplus is therefore $30… Page 136-137
  27. 27. Modeling Commodity Prices
  28. 28. Forecasting Future Commodity Price Trends D S $4 10 $1 $7 D = a – bP + cYD + eX Own price Disposable income Other factors Page 136-137
  29. 29. D S $4 10 $1 $7 S = n + mP – rC + sZ Own price Input costs Forecasting Future Commodity Price Trends Other factors Page 136-137
  30. 30. Projecting Commodity Price Page 221 D = S D S $4 10 $1 $7 D = 10 – 6P + .3YD + 1.2X S = 2 + 4P – .2C + 1.02Z Substitute the demand and supply equations into the the equilibrium condition and solve for price
  31. 31. Many Applications <ul><li>Policy decisions by Congress and the president </li></ul><ul><li>Commodity modeling by brokers and traders </li></ul><ul><li>Credit repayment capacity analysis by lenders </li></ul><ul><li>Outlook presentations by extension economists </li></ul><ul><li>Planting decisions by farmers </li></ul><ul><li>Herd size and feedlot placement decisions by livestock producers </li></ul><ul><li>Strategic planning for processors </li></ul>
  32. 32. Market Disequilibrium
  33. 33. Market Surplus At the price is P S , producers would supply Q S . Page 138
  34. 34. Market Surplus At the price is P S , consumers would only want Q D . Page 138
  35. 35. Market Surplus At the price is P S , a market surplus equal Q S – Q D exists Page 138
  36. 36. Market Shortage At the price is P D , producers would only supply Q S . Page 138
  37. 37. Market Shortage C onsumers want Q D at this low price. Page 138
  38. 38. Market Shortage C onsumers want Q D at this low price. Page 138 At the price is P S , a market shortage equal Q D – Q S exists
  39. 39. Adjustments to Market Equilibrium Markets converge to equilibrium over time unless other events in the economy occur. One explanation for this adjustment which makes sense in agriculture is the Cobweb theory . This names stems from the spider like trail the adjustment process makes.
  40. 40. Year Two Reactions Producers use last year’s price as their expected price for year 2. Consumers on the other hand pay this year’s price determined by Q 2 . Page 140
  41. 41. Year Three Reactions P 2 P 3 Producers now decide to produce less at the lower expected price. This lower quantity pushes price up to P 3 in year 3. Page 140
  42. 42. Cobweb Pattern Over Time Market equilibrium The market converges to market equilibrium where demand intersects supply at price P E . In some markets, this adjustment period may only be months or even weeks rather than years assumed here. Page 140
  43. 43. Market-to-Firm Linkages
  44. 44. Some Important Jargon We need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve.
  45. 45. Some Important Jargon We need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve. Movement along a curve is referred to as a “ change in the quantity demanded or supplied”. A shift in a curve is referred to as a “change in demand or supply”.
  46. 46. Page 135 Increase in demand pulls up price from P e to P e * Decrease in demand pushes price down from P e to P e *
  47. 47. Page 135 Increase in supply pushed price down from P e to P e * Decrease in supply pulls up price from P e to P e *
  48. 48. Merging Demand and Supply Price Quantity D S P E Q E Chapters 6-7 Chapters 3-5
  49. 49. Firm is a “Price Taker” Under Perfect Competition Price Quantity D S P E Q E Price O MAX AVC MC The Market The Firm
  50. 50. If Demand Increases…… Price Quantity D S P E Q E Price AVC MC The Market The Firm 10 11 D 1
  51. 51. If Demand Decreases…… Price Quantity D S P E Q E Price AVC MC The Market The Firm 9 10 D 2
  52. 52. Firm is a “Price Taker” in the Input Market Price Quantity D S P E Q E Price L MAX MVP MIC Labor Market The Firm
  53. 53. Firm is a “Price Taker” in the Input Market Price Quantity D S P E Q E Price L MAX MVP MIC Labor Market The Firm
  54. 54. Effects of Increasing The Minimum Wage Price Quantity D S P MIN Q D Price L MAX MVP MIC Labor Market The Firm Q S
  55. 55. Summary <ul><li>Market equilibrium price and quantity are given by the intersection of demand and supply </li></ul><ul><li>Producer surplus captures the profit earned in the market by producers </li></ul><ul><li>Total economic surplus is equal to producer surplus plus consumer surplus </li></ul><ul><li>A market surplus exists when the quantity supplied exceeds the quantity demanded. </li></ul><ul><li>A market shortage exists when the quantity demanded exceeds the quantity supplied. </li></ul>
  56. 56. Chapter 9 focuses on market equilibrium and product prices under conditions of imperfect competition ….

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