1. Lecture Five: Competitive Market
IPEM Tohoku University
Managerial Economics
Lecturer: Jack Wu
Period 1 and 2/ February 16

2. Perfect Competition homogeneous product many buyers many sellers
price takers
free entry and exit
equal information

3. 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

4. Perfect competition Many small buyers Many small sellers
buyer/seller with market power can influence demand/supply
Market 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

5. Perfect competition Free entry and exit
No entry barriers to potential competitors
No exit barriers to existing sellers

6. 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

7. 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
Medical treatment:
patients have less information than doctors
not all doctors equally informed about current medical technology and regulations
Market for medical treatment is less competitive.
Similarly, market for legal advice is less competitive.

8. Market Equilibrium, I
Price at which quantity demanded equals quantity supplied
when market out of equilibrium, market forces push price towards equilibrium

9. MARKET EQUILIBRIUM, II a excess supply supply Price ($ per ton-mile)22 b 20
equilibrium c
demand 8 10 11
Quantity (Million ton-miles a year)

10. 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

11. 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

12. SUPPLY SHIFT, II a original supply Price ($ per ton-mile) b 60 cents20
new supply
19.60 d
demand
60 cents c e 10
10.4
Quantity (Million ton-miles a year)

13. Price Elasticities of Demand
Extremely inelastic demand
Extremely elastic demand
demand
original supply
original supply b
Price ($ per ton-mile)
60 cents
60 cents
new supply 20
Price ($ per ton-mile) 20 b
demand
new supply
19.40
60 cents
60 cents c c e e 10 10
10.6
Quantity (Million ton-miles a year)
Quantity (Million ton-miles a year)

14. PRICE ELASTICITIES OF SUPPLY
Extremely inelastic supply
Extremely elastic supply
original and new supply a a
original supply b 20 b 20
Price ($ per ton-mile)
Price ($ per ton-mile)
60 cents
60 cents
19.40
new supply
demand
demand 10 10 11
Quantity (Million ton-miles a year)
Quantity (Million ton-miles a year)

15. 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

16. PROMOTING RETAIL SALES
retail supply
after wholesale price cut a
Price ($ per unit)
1.50 b
retail demand 1 Q
Quantity (Million units a year)

17. 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

18. DEMAND SHIFT, II supply a 1 million f b Price ($ per ton-mile) 20
new demand
1 million
original demand c 10
10.8
Quantity (Million ton-miles a year)

19. Tanker services, 2005 Increasing oil prices Increasing China imports
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

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

21. 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

22. Calculating Equilibrium, II
% change in qty demanded = %p x 3
% change in qty supplied = %p
equate and solve: %p = 1.38%
% change in qty = 0.87%

23. SHORT-RUN MARKET EQUILIBRIUM
(a) Individual seller
(b) Market
short-run
marginal cost
short-run
supply
short-run
average
variable cost
1 million c 22
Price ($per ton-mile) 22
Price ($ per ton-mile) 20 20 a
price
short-run
demand
100
105 10 12
Quantity (Thousand ton-miles a year)
Quantity (Thousand ton-miles a year)

24. LONG-RUN MARKET EQUILIBRIUM
(a) Individual seller
(b) Market
new long-run
average cost
long-run
marginal cost
long-run
supply
1 million d
Price ($per ton-mile)
Price ($ per ton-mile) 21 21 20 20 a
original long-
run average
cost
long-run
demand
100 10 13
Quantity (Thousand ton-miles a year)
Quantity (Thousand ton-miles a year)

25. 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

26. Demand increase
This figure combines short-run with long-run analysis at market level

27. Demand reduction
This figure combines short-run with long-run analysis at market level

28. Pricing and Freight Cost, I
cost and freight
ex-works pricing
How does pricing policy affect sales?

29. PRICING AND FREIGHT COST, II
CF supply
25 cents
25 cents
ex-works supply a
Price ($ per pound)
1.50 b
CF demand
ex-works demand 1
Quantity (Million pounds a year)

30. Retailing: Why coupons?
alternative -- cutting wholesale prices
“With coupons, prevent retailers from getting part of price cut.”