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Demand analysis

Firms sell goods/services to buyers


Consumers (individuals) : utility Firms : make profits

Willingness to pay: maximum price buyer will pay for a good


Point of indifference between buying and not buying Lower price always preferred by buyer

Willingness to pay is determined by


Buyers tastes or needs Income and wealth
Normal/inferior goods Cyclical/acyclical demand

Substitutes Complementary goods

Demand curve for an individual buyer


Willingness to pay for different quantities of the good Or, quantity demanded at each price Usually downward sloping: lower willingness to pay for additional units
Lower utility of consumption for consumers Lower productivity of resources for firms

Shifts in demand curve

Market demand
Sum of individual demand curves Aggregate quantity demanded at each price Arrays individual buyers in order of willingness to pay Identical goods? Product differentiation?

Market segments / Price discrimination


Different segments willing to pay different prices Consumer surplus Can firms exploit this?
Feasible? Fair?

Price sensitivity of demand


Slope of market demand curve Flat demand curve: very price sensitive: Elastic
Goods with good substitutes Luxury items ?

Steep demand curve: less sensitive: Inelastic


Necessities

Time-frame: easier to find substitutes over long run Demand curves


Accept as given? Seek to modify?

Supply analysis
Supply curve
How much the firm will sell at each price Assumption: price-taking firm

Time-frame of supply decision


Long run: compete in the market at all? Short run: how much to produce & sell?

Short run supply Based on costs


Fixed costs: incurred regardless of volume
headquarter costs, depreciation, rent, labor.

Variable or marginal costs: cost per additional unit produced


Raw materials, electricity, labor.

In the short run, fixed costs are inevitable Should not affect short run supply decisions (?)

Marginal costs
Cash costs: out-ofpocket Opportunity costs: foregone profits

Marginal cost curve : Short run supply curve

Long run supply: entry & exit Recover both fixed and variable costs Fixed costs
Out-of-pocket costs Opportunity costs: return on capital

Average costs
Includes both fixed and variable costs Typical U shape Minimum of the average cost curve: Optimal long run supply point Market price must exceed price at this point Determine entry and exit Dynamics?

Shifts in supply curve


Input costs Technology

Market supply curve


Sum of individual supply curves Usually slopes upward
Less efficient firms enter market when price is high Arrays firms from most efficient to least

Supply elasticity
Flat supply curve: very sensitive to price: Elastic Steep supply curve: less sensitive: Inelastic

Varies over the range of output


Elastic when spare capacity is available Inelastic when capacity constrained

Market equilibrium
Interesection of market demand and supply curves Disequilibrium will cause price to adjust and yield new equilibrium Real world: series of small disequilibriums, series of price adjustments Currency markets: rapid, continuous adjustments

Profit calculation based on equilibrium price Average and marginal costs Marginal cost determines supply volume Average costs at that volume

Market adjustment
Shifts in demand and supply curves
Increase: shift to the right Decrease: shift to the left

Impact on quantity and price

Inelastic curves: adjustment largely through price Elastic curves: adjustment largely through quantity Short run versus long run

Perfect competition
Three assumptions:
1. Identical products 2. Many small price-taking buyers and sellers 3. Full information

Excess profits more firms enter increased supply lower price zero excess profits

Three more conditions:


1. Identical sellers 2. Free entry 3. Free exit

Zero excess profits Long run profitability?

Departures from perfect competition


Most markets have far from perfect competition
Exceptions: commodities

Secret of long run profitability: deviations from perfect competition Few sellers or buyers
Extreme case: monopoly or monopsony Oligopoly
Collusion Cartels: incentives to cheat the cartel

Societal impact: anti-trust regulation

Entry and exit barriers


First mover advantage
Headstart on learning curve Economies of scale Reputation and branding

High exit costs


May lead to firms accepting sustained losses

Product differentiation
Special attributes: Real or imaginary

Differences among sellers


Least cost producer Innovation

Imperfect information
Search costs protect existing relations and discourage competition