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Market equilibrium
- 1. Market Structure and Equilibrium We will consider the two extreme cases Perfect Competition Monopoly
- 2. Market Efficiency • Decision makers in a market behave rationally and have full access to all relevant behavior. • Consumer and producer surplus is maximized
- 3. Determinants of Market Structure • Number and size of buyers, sellers, and potential entrants, • Degree of product differentiation • Amount and cost information about product price and quality, and • Conditions for entry into and exit from a market
- 4. Market Equilibrium Perfect Competition • Supply forces (producers) and demand forces (consumers) seek a balance • Price below perceived value increases demand • Price above ATC provides pure profit, an incentive to increase supply Supply curve Demand curve Q P Pe
- 5. Individual Firm’s Demand and MR Curve Q P Pe Highly elastic demand One firm’s change in Q has little effect on price ∆Q ∆P
- 6. Market Equilibrium Perfect Competition • Price above ATC provides pure profit, an incentive to increase output • Pure profit equals (P1 x Q1) – (P2 x Q2) P1 MC ATC Price (P) P2 Q2 Q1 Individual Firm
- 7. Market Equilibrium Perfect Competition • All firms are price takers • Market price (P1) equals marginal revenue (MR) and average revenue (AR) • Optimal level of output is where MR = MC = P1 • In long-run P will go to P2 where pure profit is eliminated P1 MC ATC Price (P) P2 Q2 Q1 Individual Firm
- 8. Market Supply Curve Summation of supply curves for individual firms Joe’s sawmill Pete’s sawmill Tracy’s sawmill Janet’s sawmill Market supply curve Q P Sum vertically + + + = Qm Qj Qt Qp Qj Demand Pm (same P for all firms and market)
- 9. Perfect Competition - Example • Given supply and demand functions, Qs = 30 + 55 P Qd = 230 – 45 P • Determine marginal revenue, MR, i.e. Pe, from supply and demand curves for total market. Calculate Pe from market supply equals demand equilibrium condition, Qs = Qd 30 + 55 P = 230 – 45 P 100 P = 200 P = 2 = MR • Use P to get equilibrium quantity, Qe Qe = 230 – 45 x 2 = 230 –90 = 140
- 10. Apply Market Price to Individual Firm – “Pete’s Sawmill” P = $2 from market equilibrium Determine quantity Pete should produce from Pete’s marginal cost (MC) curve, which is, Qs = 5 + 5.8 P = 5 + 5.8 x 2 = 16.6
- 11. Market Equilibrium Monopoly • Only one producer – Producer is a price “setter”, not a price taker • Demand curve restricts ability to set price – Demand curve determines marginal revenue (MR) • Only way to change quantity sold is to change market price • Marginal revenue (MR) is not constant • What forces lead to a monopoly
- 12. Market Equilibrium Monopoly Q P Monopolists MC curve Market demand curve Monopolists MR curve MC = MR to max. profit Qe determine fist, then get P from demand curve Pe Down to get Q Up & over to get P e stands for equilibrium
- 13. Marginal Revenue Curve • TR = P x Q • Demand curve – P = a – bQ • TR = (a – bQ ) x Q = aQ – bQ2 • MR = dTR/dQ = a – 2b Q • Same intercept and 2x slope of demand curve
- 14. Market Equilibrium Monopoly compared to competitive equilibrium Q P Monopolists MC curve Market demand curve Monopolists MR curve Qm Pm Qc Pc m – monopoly equilibrium c – competitive equilibrium
- 15. Market Equilibrium Monopoly Compared to competitive market equilibrium – Monopolist produces (sells) smaller quantity at higher price
- 16. Monopoly – Example Given, same supply and demand curves as in competitive example, Qd = 230 – 45 P (given), or P = 5.11 – 1/45 Q Qs = 30 + 55 P (given), or P = 0.545 + 1/55 Q Determine marginal revenue curve: Revenue = P x Q = Q (5.11 – 0.022 Q) = 5.11 Q – 0.022 Q2 MR = 5.11 – 0.044 Q
- 17. Monopoly – Example, cont. Equate MC and MR to determine Q: 5.11 – 0.044 Q = 0.545 + 0.018 Q 4.57 = 0.062 Q Q = 74 Substitute Q into demand curve to get P, P = 5.11 – 0.022 x 74 = 3.48 Compare the solutions for the two types of markets, Competition: P = 2.00, Q = 130 Monopoly: P = 3.48, Q = 74
- 18. Monopsony • One buyer and many sellers • Common in forest products markets – Bulky and heavy commodity – High transportation cost – Limits haul distance • How can sellers gain market power?