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Economics for Management Studies
Michael Krashinsky

1 Week 2: Demand and Supply in a Competitive Market What did we learn last week? - definition of economics - opportunity cost - production possibilities model - calculating opportunity cost on PPF - PPF with increasing costs - maximizing a value (or utility) function along PPF 2 Agenda for this week: - Overview (build-up) of the competitive market model - What is a market? - What is competition? - Demand - Supply - Equilibrium - Shifts in Demand and Supply: how they affect equilibrium 3 What is a market? A set of institutional arrangements that bring buyers and sellers together to negotiate the terms for exchanging goods or services Good = tangible Service = intangible 4 Bushels of apples in Toronto Price Supp ly $28 $20 Deman $16 d $12 8 0 16 32 Quantity Per month (in thousands of bushels) 5 Demand curve – behaviour of buyers Demand has negative slope. Why? Diminishing Marginal Utility (i.e. dim MQ ) We usually assume that, all else the same, our marginal utility declines as we add incremental units of consumption. Suppose we consider the impact of consuming (additional) bowls of rice. Number Total Marginal Max of Bowls Utility Utility Price (daily) (in $) (willingness to pay) 0 0 0 1 8 8 2 13 5 3 15 2 4 16.75 1.75 6 Market for (bushels of) apples in Toronto (in September) Price The Demand Curve shows the $60 MAXIMUM price consumers are willing to pay (per unit) for any particular quantity $50 $30 $25 Demand 10 30 35 Quantity Per month (in thousands of bushels) 7 Supply curve – behaviour of sellers In short-run, supply has positive slope. Why? The Supply Curve shows the MINIMUM price suppliers are willing to charge (per unit) for any particular quantity (this min price equals the firms marginal cost of production & Increasing marginal cost makes Supply upward sloping) Supply in SR = now, with existing firms only, using their existing productive capacity (but varying amounts of labour) In long-run, supply is less steeply sloped. Often is horizontal (zero slope) 8 Equilibrium occurs when the behaviour of buyers and sellers is consistent (the amount buyers want to buy matches the S d amount sellers want to sell, Q = Q ) Price brings these behaviours into equilibrium!!! Prices play a key role in markets (they help the invisible hand to function) 9 What is competition? (Perfectly Competitive Market) 1. Many buyers, many sellers (price takers) 2. Product is homogeneous or standardized (little brand loyalty) 3. Perfect information (no one is fooled) 4. Free entry and exit in LR (no barriers to entry or exit) Therefore, (a) producers/consumers have no market power, and (b) price competition is main form that competition takes (!!!) 10 Demand Curve – negatively sloped (What does this mean?) Law of Demand (check it on Wikipedia) Q = 60 – P or P = 60 - Q D D (doesn’t have to be linear; could be Q = 10P -1= 10/P) D 11 Is Price the only factor that affects Demand? No, really… Q D f(P, P , S , C, Pop , Tastes…) So, the true demand function could be: Q D 40 – P + 4P – SP + .C2I + .5N + .05T Which we simplify to Q = 6D – P by assuming certain values for all the other variables and absorbing this into the constant term (above we assumed the value of other terms sums to 20) Note: 1) Quantity
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