Introduction to Agricultural and Natural Resources

Markets and Market EquilibriumFREC 150

Dr. Steven E. Hastings

Markets and Market Equilibrium • This Outline Covers the additional parts of Chapter 8 (pages 133 – 140)

and parts of Chapter 9 (pages 145 – 148 and 155 – 158) in Penson et al.

• Major Topics– Markets– Market Structure– Perfect Competition– Market Equilibrium– Shifts in Supply and Demand– Implications of Market Structure for Society– Imperfect Competition– Summary

Markets• What is a Market?

– A market is an institution or an arrangement that brings buyers and sellers of a product together.

– Examples: NYSE, retail stores, yard sales, book buy-back, antique auction, etc.

• The Role of Markets (Previous Text)

– Markets direct and coordinate the transformation (form, space and time) of resources in to goods and services that provide utility.

– Form - involved changing the form of resources; corn vs. corn flakes, Pop Tarts. – Space - consumers want goods and services at a particular location, regardless of where it is

produce; orange juice for breakfast.

– Time - an important factor in determining the amount of utility a good; frozen, sealed, etc.

Market Structure

• Within an economic system, the “structure” of different product (and resource) markets can vary, depending on:

– Numbers and size of sellers– Homogeneity of the product (product differentiation) – Ease of entry and exit by firms (barriers) – The economic environment of the industry

Examples

Typical Market Structures

For sellers in the product market:

For buyers in the input market:

Perfect Competition Perfect Competition Imperfect Competition Imperfect Competition Monopolistic Competition Monopsonistic Competition Oligopoly Oligopsony Monopoly Monopsony

From the Text

Advertising Creates “Difference” in Products

Perfect Competition

• Perfect Competition in a product market requires:

– Product is homogeneous (corn is corn!)– No barriers to a firm entering or exiting the market (no patents,

licenses, etc,)– Large number of sellers (no sellers can “set” the price)– Information is available to all.

• An Iowa corn farmer is a good example of a perfect competitor (seller).

Market Equilibrium• Market Equilibrium occurs when the quantity of good offered at a price

equals the quantity consumers are willing to purchase at that same price.

– The market price is the mutually agreeable price at which buyers and sellers exchange a good. At that price, the market is in equilibrium (the equilibrium price): the quantity offered is the same as the quantity demanded.

– Any price other than the equilibrium price is a disequilibrium price. At any of these prices (supply does not equal demand), the quantity offered and the quantity demanded are not equal and either a surplus (prices above the equilibrium price) or shortage (prices below the equilibrium) exists.

Graphically,

Graphically Again,

Firms are “Price Takers”

Shifts in Market Supply and Market Demand and Create Disequilibrium

What causesshifts in Demand?

What causesShifts in Supply?

Shifts in Market Supply and Market Demand and Create Disequilibrium

A - New HealthFood Fad

C – New TechnologyLowers Cost

B – Health Scare –Eggs, Beef, Grapes, etc.

D – Hurricanes, Drought, etc.

Market Disequilibrium(s)

Market Structure is Important for Society

 

• Perfect Competition and Imperfect Competition

–The structure of the market has many implications for the production of goods and services, the use of resources and for society's welfare.

–Perfect Competition is considered efficient in the long-run and Imperfect Competition is not.

Price and Output in a Competitive Market (SR and LR)

– In the short run, a firm faces a horizontal demand schedule at the market price. This is their MR, which is equated to their MC to determine the amount of output to be produced. Output is determined by price (which is determined by the market supply and demand).

– In the long run, firms can enter the market if profits are being made or leave the market if profits are not being made. This continues until the LR equilibrium is reached (price equals minimum LRAC). Price and output are determined by the long run costs of production.

Implications

• In Perfect Competition: no firm can control or influence price –

- thus, consumer demands are satisfied by the production of the optimum amount of goods and services; and

- in turn, resources are optimally allocated to the production of the goods and services; and

- consumer utility is maximized and firm's economic profits are maximized (but, zero in the long run) and

- overall, society's welfare is maximized.

- This is Adam’s Smith “Invisible Hand” postulated in 1776!- This is usually used as a standard but is rarely achieved.

Adam Smith • Adam Smith (baptised 16 June 1723 – 17 July

1790) was a Scottish moral philosopher and a pioneer of political economy. Smith is the author of An Inquiry into the Nature and Causes of the Wealth of Nations. The latter, usually abbreviated as The Wealth of Nations, is considered the first modern work of economics. Adam Smith is widely cited as the father of modern economics.

• In economics, the invisible hand the term economists use to describe the self-regulating nature of the marketplace, is a metaphor first coined by the economist Adam Smith. The invisible hand was created by the conjunction of the forces of self-interest, competition, and supply and demand, which he noted as being capable of allocating resources in society. This is the founding justification for the laissez-faire economic philosophy.

• Source for text and image: Wikipedia

Imperfect Competition

 • Imperfect competition exists when an individual firm has some control over the

price of the product it sells. Then, society's welfare is not maximized.

• Profit Maximizing in a Monopoly

– In a pure monopoly, there is one producer, no other firms to enter the market, and a differentiated product.

– To maximize profit, a firm faces the market demand curve. MR is declining. MR and MC are equated, but the price charged is greater than MR = MC.

– This is the loss, the inefficiency, to society – the firm is paid more that the cost of the resources used – excess profit. There are no competing firms to enter the market to reduce the excess profits

Most Extreme Case: Monopoly

No other firms can enterthe market to capture profits.

Summary

• Markets are the links between buyers and sellers in our economic system.• They coordinate the transformation of scarce resources into products and

services that satisfy wants. • Market structure has implications for the efficient use of resources in

society.• Market structure can vary from perfect competition ( ) to monopoly ( ).

• Lecture Sources: Text and Miscellaneous Materials

Markets and Market Equilibrium • Summary

– The concept of supply is used to model and measure producer behavior in our economic system

– Typical production costs and are the basis for the supply curve.

• Lecture Sources: Text and Miscellaneous Materials