Demand, Supply, and Equilibrium in a Perfectly Competitive Market

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Demand, Supply, and Equilibrium in a Perfectly
Competitive Market
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The Context Perfectly Competitive Markets

• A group of buyers and sellers of a particular
  good or service
• can be defined narrowly or broadly (e.g., rice
  vs. food)
• at a given point in time (e.g., day, month, year)
• Enough buyers and sellers so that no one has an
  impact on the price
• typical with many buyers and sellers

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Willingness to Pay

• Willingness to pay (WTP) the maximum amount that
  a buyer will pay for a good
• Further distinctions are helpful
• Marginal willingness to pay (MWTP) WTP for one
  more unit of a good
• Total willingness to pay (TWTP) WTP for any
  number of units of a good

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An Individuals WTP for good X
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An Individuals Demand Curve

• A graph of an individuals MWTP curve is her
  demand curve
• Demand curve gives the relationship between the
  price of a good and the quantity demanded
• Law of demand downward sloping curve reflects
  diminishing MWTP

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An Individuals Demand Schedule

• A table that gives the relationship between the
  price and quantity demanded
• Based on the individuals MWTP

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Consider a Market with Two Individuals
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The Market (Aggregate) Demand Curve

• A horizontal summation of individual demand
  curves
• Tells the market quantity demanded at any given
  price
• Also tells the MWTP in the marketthe most
  someone is WTP for each additional unit of the
  good

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A Note on Demand Semantics

• Changes in price result in changes in the
  quantity demanded
• Changes in demand imply shifts of the demand
  curve

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Shifters of the Demand Curve

• Changes in income, (-)
• Normal goods, (-)
• Inferior goods, - ()
• Changes in the price of related goods, (-)
• Substitutes, (-)
• Complements, - ()
• Tastes and preferences
• Expectations
• Number of buyers in the market, (-) implies
  (-)

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A Firms Marginal Cost (MC) of Production

• Marginal cost (MC) tells a firms incremental
  cost of producing an additional unit of a good
• We assume it is increasing (for now)
• We ignore the total costs of production (for now)

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A Firms MC of Producing Good X
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An Firms Supply Curve

• A graph of a firms MC curve is its supply curve
• Supply curve gives the relationship between the
  price of a good and the quantity supplied
• Law of supply upward sloping curve reflects
  increasing MC

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A Firms Supply Schedule

• A table that gives the relationship between the
  price and quantity supplied
• Based on the firms MC

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Consider a Market with Two Firms
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The Market (Aggregate) Supply Curve

• A horizontal summation of the individual firm
  supply curves
• Tells the market quantity supplied at any given
  price
• Also tells the MC in the marketthe lowest cost
  of producing each additional unit of the good

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A Note on Supply Semantics

• Changes in price result in changes in the
  quantity supplied
• Changes in supply imply shifts of the supply
  curve

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Shifters of the Supply Curve

• Changes in input prices, (-) implies - ()
• Changes in the technology of production, such
  that better (worse) implies (-)
• Expectations
• Number of sellers in the market, (-) implies
  (-)

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Equilibrium Supply meets Demand

• The intersection of the supply and demand curves
  determines the equilibrium price and quantity
• Market clearing condition when the quantity
  supplied equals the quantity demanded
• Given the equations for the supply and demand
  curves, you can solve algebraically for P and Q

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Equilibrium Proof by Contradiction

• If P gt P, then there would be excess supply (a
  surplus)
• Firms would lower prices
• If P lt P, then there would be excess demand (a
  shortage)
• Consumers would pay more
• Must be true that P P and that QS QD Q

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Comparative Static Analysis

• Ceteris paribus other things being equal
• An increase (decrease) in demand results in more
  (less) exchange at a higher (lower) price
• An increase (decrease) in supply results in more
  (less) exchange at a lower (higher) price
• Simultaneous shifts in supply and demand can
  generate ambiguous effects