micro analysis
Post on 29-Jun-2015
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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– Buyer’s 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-of-
pocket– 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
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