Objectives:
How Supply & Demand curves interact to determine the prices & quantities of goods & services produced & consumed
About markets in time, space, & formCharacteristics of a competitive marketDetermination of Output in a competitive
market
Economic Profit
Total Revenue
Explicit Costs
Accounting Profit
Explicit Costs
Economic Profit
“Normal” Profit
“Normal” Profit is the opportunity cost of resources supplied by owner of the firm; Economic profit (excess profits) are profits above opportunity costs and explicit costs
Stay in Farming Manage Retail Store
TR = $22,000 Explicit Costs = $10,000 Implicit Costs = $11,000 Accounting Profit = $12,000 Economic Profit = $1,000
TR = $11,000 Explicit Costs = $0 Implicit Costs = $11,000 Accounting Profit = $11,000 Economic Profit = $0
Pudge the Corn Farmer
Competition
Suppose that economic (excess) profits were that high for corn farming, would Pudge be the only person wanting to farm corn?
Excess profits attract new entrants into the business with similar opportunity costs as Pudge. For those with OC less than
Pudge, farming is very attractive For those with OC equal to Pudge,
they are indifferent about farming For those with OC greater than
Pudge, farming is not attractive
Markets
A Market is an institution or an arrangement that brings buyers and sellers together.
Market Price - is the mutually agreeable price at which willing buyers and willing sellers exchange a good.
Market Equilibrium
Market equilibrium occurs when the quantity of a good offered by a sellers at a given price equals the quantity buyers are willing and able to purchase at that same price. Like the two blades of scissors—which one cuts the
paper?
Numerical Example
1
000,10000,10
000,5000,5000,10
000,5
000,5000,10
p
p
pp
pQ
pQ
sd
s
d
In equilibrium, demand and supply must equal one another:
The equilibrium price is $1. To get quantity, simply substitute $1 into either supply or demand: Q = 5,000p = 5,000 sandwiches.
Numerical Example—Input Cost Increase
Increase in minimum wage shifts supply function
11.1
000,9000,10
000,4000,5000,10
000,4
p
p
pp
pQ
sd
s
The increase in the minimum wage increased the equilibrium price of chicken sandwiches by $0.11
Numerical Example—Demand Increase
News of healthy chicken increases demand
20.1
000,12000,10
000,5000,5000,12
000,5000,12
p
p
pp
pQ
sd
d
The health news increased demand, increasing price by $0.20.
Functions of Price
Rationing—distribute scarce goods among potential claimants insuring that those that get them are the ones that value them the most
Allocative—direct productive resources to different sectors of the economy
Graphs
Firm profitEquilibriumExcess Profits and New EntryShort-run vs. Long run effects of demand and
supply changes
No-Cash-On-The-Table
If the price is “too low,” consumers will buy more to capture their “excess profits” by consuming products at a price less than they were willing to pay
If the price is “too high,” producers will produce more to capture their “excess profits” by producing products at a price more than they willing to accept
No-Cash-On-The-Table
Why are all lanes on a crowded, multi-lane freeway moving at about the same speed?
Why do grocery check-out lines all tend to be about the same length?
Perfect Competition
Large number of buyers and sellers At least a relatively large number of comparably sized
firmsRelatively homogeneous products
Basic commoditiesLow barriers to entry
Relatively easy to get in and out of the marketEconomic conditions
Small portion of consumer’s budget and relatively large production
Economic Rent vs. Economic Profit
Profit is earnings above explicit and implicit costs; these are driven toward zero by competition
Rent is payment for a factor of production in excess of the reservation price Influenced by the “uniqueness” of the input
Efficiency (Pareto Efficiency)
Efficiency—if price and quantity take anything other than their equilibrium values, a transaction that will make someone better off without making anyone else worse off can always be found
A perfectly competitive market is the most efficient market form. It results in the highest possible total welfare of everyone in the market.
Surplus
Surplus is simply the economic benefits less the costs
In equilibrium, surplus is the total economic benefits accumulated from consuming/producing a good across all units at the equilibrium price. Consumer surplus is the area under the demand curve
and above the equilibrium price Producer surplus is the area above the supply function
and below the equilibrium price (also called profit)
Calculation
Consumer surplus is given by:
Producer surplus is given by:
02
1 ** QPPCS d
002
1 ** QPPS
Numerical Example
Back to our chicken sandwich example:
2
000,10000,5
000,5000,100
000,5000,10
p
p
p
pQd
First find Pd :
Set demand = 0 to get y-intercept:
dayCS
CS
CS
/500,2$
000,52
1
0000,5122
1
Find surplus:
dayPS
PS
PS
/500,2$
000,52
1
0000,5012
1
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