1. Market Equilibrium and Market Demand: Perfect Competition Chapter 8

2. Discussion Topics Derivation of market supply curve Elasticity of supply and producer surplus Market equilibrium under perfect competition Total economic surplus Adjustments to market equilibrium 2

3. Page 131 Remember the firm’s supply curve? Remember the firm’s supply curve? P=MR=AR 3

4. Page 131 P 3 =MR 3 =AR 3 Firm’s supply curve starts at shut down output level  Where MR < AVC Firm’s supply curve starts at shut down output level  Where MR < AVC P 1 =MR 1 =AR 1 P 2 =MR 2 =AR 2 Profit maximizing firm will desire to produce where MC=MR Economic losses occur where MC > MR Economic losses occur where MC > MR 4444444444

5. Page 132 Building the Industry Supply Curve Market supply curve: The horizontal summation of the supply decisions of all firms in the market  At a price of $1.50, Gary would supply 2 tons of broccoli Market supply curve: The horizontal summation of the supply decisions of all firms in the market  At a price of $1.50, Gary would supply 2 tons of broccoli 5

6. Page 132 Building the Industry Supply Curve Market supply curve: The horizontal summation of the supply decisions of all firms in the market  At a price of $1.50, Ima would supply 1 ton of broccoli Market supply curve: The horizontal summation of the supply decisions of all firms in the market  At a price of $1.50, Ima would supply 1 ton of broccoli 6

7. Building the Industry Supply Curve Market supply curve: The horizontal summation of the supply decisions of all firms in the market  At a price of $1.50 market supply would be 3 tons Page 132 7

8. Determining Market Equilibrium With the above we have identified the Market Supply Curve Previously we derived the Market Demand Curve  Horizontal summation of individual demand curves We can combine these concepts to identify what is referred to as the Market Equilibrium 8

9. Price Quantity D S PEPE QEQE Determining Market Equilibrium Market clearing price Market Supply Curve Market Demand Curve 9

10. Price Quantity D S PEPE QEQE Determining Market Equilibrium Chapters 3 - 5 10

11. Price Quantity D S PEPE QEQE Factors that change (shift) demand:  Prices of other goods  Consumer income  Tastes and preferences  Real wealth effect  Global events D* Q E* P E* Determining Market Equilibrium 11

12. Price Quantity D S PEPE QEQE Determining Market Equilibrium Chapters 6 - 7 12

13. Price Quantity D S PEPE QEQE Factors that change (shift) supply:  Input costs  Government policy  Price expectations  Weather & disease  Global events Q E* P E* S* Determining Market Equilibrium 13

14. Concept of Producer Surplus Producer Surplus (PS) is a term economists use for profit PS measured as the area above the supply curve and below market equilibrium price →Total Economic Surplus (TES) = Consumer Surplus (CS, Chapter 4) + PS Page 133 14

15. Page 133 F Product Price Market Price of $4 A B PS at $4 = area ABC Concept of Producer Surplus Market Supply $4 C Output Price 15

16. Page 133 F B PS at $6 = area EDC Concept of Producer Surplus Market Supply $4 C $6 Suppose Price Increased to $6… E D G A Output Price 16

17. Page 133 F B Concept of Producer Surplus Market Supply $4 C $6 E D The gain in PS if the price increases from $4 to $6 is equal to area AEDB A Producers are better off by increasing output from F to G G Price Output 17

18. Assessing Economic Welfare We can use the concepts of market demand and supply to  Assess the effects of events in the economy on the economic well being of consumers and producers  For a particular market  During a specific time period We do this using the concept of total economic surplus (TES) defined as: TES = CS + PS Total Consumers Producers 18

19. An Example of Economic Welfare Analysis Page 136-137 Assessing Economic Welfare Assume a drought occurs Before this happened  PS = area BCA  CS = area BCD  TES = area BCA + area BCD = area ADC A B C D Q $ 19

20. An Example of Economic Welfare Analysis Page 136-137 Assessing Economic Welfare A B C D E F G H Assume the drought causes supply curve to shift up After the drought  PS = area FEH  Gain BFEG + Loss AHGC  CS = area FDE  Loss of BFEG + GEC  TES = area HDE  Loss of AHGC + GEC Q $ 20

21. An Example of Economic Welfare Analysis Page 136-137 Assessing Economic Welfare A B C D E F G H Drought causes  Consumers to be worse off as no gain area  Producers are worse off if area BFEG (gain) is less than AHGC (loss)  Area BFEG is transferred from consumers to producers  Society is on net worse off as no gain area (area AHEC) Q $ 21

22. Measuring Surplus Levels Product price D Supply 10 CS = (10 x (6-4))÷2 = $10 Page 136-137 Assessing Economic Welfare PS =(10 x (4-1))÷2 = $15 →Total economic surplus = CS + PS = $10 + $15 = $25 →Total economic surplus = CS + PS = $10 + $15 = $25 A B C E F ABCD = ? FADE = ? 22 $4 $1 $6 Demand $ Q

23. Modeling Commodity Prices 23

24. Page 136-137 S $4 10 $1 $6 Other factors Other factors D D = α – βP + γY D + δX Input costs Input costs Other factors Other factors S = θ + πP – τC + χZ Own price Own price Own price Own price Disposable income Disposable income Forecasting Future Commodity Price Trends Modeling Commodity Prices 24 $ Q

25. Page 221 Q D = Q S S P* D Q D = 10 – 6P +.3Y D + 1.2X (1)Substitute demand and supply equations into equilibrium condition (2)Solve for equilibrium price (P*) (3)Substitute this price into either supply or demand equation for Q* 25 Modeling Commodity Prices Q* Q S = 2 + 4P –.2C + 1.02Z Determining P* and Q* $ Q Assume you know Y D, X, C and Z

26. Many Applications Policy decisions by Congress and the President Commodity modeling by brokers/traders Lender credit repayment capacity analysis Outlook presentations by extension eco. Farm planting decisions Livestock producers herd size and feedlot placement decisions Strategic planning for processors 26

27. Market Disequilibrium 27

28. At P S → Market Surplus exists = Q S - Q D Page 138 At price P S, producers would supply Q S At price P S, consumers would demand Q D 28 Market Disequilibrium QDQD QSQS PSPS PDPD P* Q* D S Surplus

29. At P D → Market Shortage exists = Q S - Q D Page 138 At price P D, consumers would demand Q S At price P D, producers would supply Q D 29 Market Disequilibrium QDQD QSQS PSPS PDPD P* Q* D S Shortage

30. Market Disequilibrium Markets converge to equilibrium over time unless other events in the economy occur  One explanation for this adjustment which makes sense for agriculture is the Cobweb theory  This names comes from the spider web- like trail the adjustment process makes 30

31. Market Disequilibrium Lets use the example of a grain producer Producers tend to use last years price (year 1) as their expected price for this year (year 2) Alternatively, consumer’s pay this years price determined by market equilibrium Q 2 31

32. Year Two Reactions Page 140 Market Disequilibrium 32

33. Year Three Reactions P2P2 P3P3 Page 140 Market Disequilibrium 33

34. Year Four Reactions P4P4 P3P3 Page 140 Market Disequilibrium Producer decision based on Year 3 Price Consumer decision based on Year 4 Price Q4Q4 34

35. Page 140 Market Disequilibrium From the above results we have the following:  (P 1 – P 2 ) > (P 3 – P 2 ) > (P 3 – P 4 )  (Q 2 – Q 1 ) > (Q 2 – Q 3 ) > (Q 4 – Q 3 )  Eventually wil converge to P*, Q* the equilibrium price and quantity 35 Price changes are getting smaller Quantity changes are getting smaller

36. Page 140 The market converges to an equilibrium price and quantity  Q D = Q S at P E In some markets, adjustment period may months, weeks or years  Depends on production time required Market equilibrium Market equilibrium Cobweb Pattern Over Time Market Disequilibrium 36

37. Market-to-Firm Linkages 37

38. Some Important Jargon We need to distinguish between  Movement along a particular demand or supply curve  Referred to as a change in quantity demanded or supplied  Shifts in the demand or supply curve  Referred to as a change in demand or supply 38

39. Page 135 Increase in demand increases price from P e to P e * Decrease in demand decreases price from P e to P e * Decrease in demand decreases price from P e to P e * 39

40. Page 135 Increase in supply decreases price from P e to P e * Increase in supply decreases price from P e to P e * Decrease in supply increases price from P e to P e * Decrease in supply increases price from P e to P e * 40

41. Merging Demand and Supply Price Quantity D S PEPE QEQE Chapters 6-7 Chapters 3-5 41

42. Firm is a Price Taker Under Perfect Competition Price Quantity D S PEPE QEQE Price QFQF AVCMC The Market The Firm P E = MR = MC 42

43. Impact of an Increase in Demand Price Quantity D S PEPE QEQE Price AVC MC The Market The Firm 10 11 D1D1 Q*EQ*E 43

44. Price Quantity D S PEPE QEQE Price AVCMC The Market The Firm 9 10 D2D2 Impact of a Decrease in Demand Q*EQ*E 44

45. Firm is a Price Taker in the Input Market DLDL SLSL PLPL QLQL LFLF MVP MIC Labor Market The Firm Labor Wage Rate Wage Rate 45

46. Wage Rate Labor DLDL SLSL PLPL QLQL LFLF MVP MIC Labor Market The Firm L*FL*F Wage Rate Firm is a Price Taker in the Input Market 46 D L*

47. Effects of Increasing The Minimum Wage D S P MIN QDQD L MAX MVP MIC Labor Market The Firm QSQS Wage Rate Wage Rate Labor 47

48. Summary Market equilibrium price and quantity are given by the intersection of demand and supply Producer surplus captures the profit earned in the market by producers Total economic surplus is equal to producer surplus plus consumer surplus A market surplus exists when the quantity supplied exceeds the quantity demanded. A market shortage exists when the quantity demanded exceeds the quantity supplied. 48

49. Chapter 9 focuses on market equilibrium and product prices under conditions of imperfect competition…. 49