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Chapter 2

ECON202 Chapter Notes - Chapter 2: Exogeny, Monopolistic Competition, Market Power

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Harvey King

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Module 2: Economic Markets
Learning Objectives
At the end of this module, students should be able to do the following:
Explain how to derive a consumer’s demand for a product from the comparison of marginal
benefit and price, including being able to explain why demand curves slope downwards.
Explain how to derive a firm’s supply of a product from the comparison of marginal cost and
price, including being able to explain why supply curves slope upwards.
Given a change in an exogenous variable, be able to explain and show the impact of that
variable on demand or supply (or both).
Be able to explain how a market comes to an equilibrium price and quantity.
Given a shock to a market (a change in an exogenous variable), be able to explain how the
market adjusts to a new market equilibrium with a new price and quantity.
Most importantly, be (somewhat) comfortable with the use of graphs to explain economic
changes. We will use these through the course in many of the modules.
Be able to begin to understand how different types of markets work, and how they are affected
by positive and negative shocks of the economy. (That is, if someone asks you, what will happen
to Market X if Event Y happens, you will be able to work it out!)
2.1 Introduction to Market Types
There are a wide variety of types of markets in a modern capitalist economy, with the key
difference dependent on the market power of the buyers or sellers, with the market power
dependent on the market size of the buyers or sellers or the available substitutes for the good
Type of Market
The table below shows the basic types of markets.
Type of Market
Demand Side
Supply Side
Perfect Competition
Many buyers, no market
Many sellers, no market
Consultants, small farmers in
some markets
Many buyers, no market
One Seller (no close
Drug with a patent
One Buyer (no close
Many sellers, no market
Sports teams with a draft
Many buyers, no market
Many sellers, some
market power
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Many buyers, no market
A few sellers, lots of
market power
Cell Phone Companies
A few buyers, lots of
market power
Many sellers, no market
Big auto companies and their
We will focus on markets with a fair degree of competition on both sides, since this covers most
of the relevant markets for our purposes.
This includes perfect competition, monopolistic competition, and the oligopoly/oligopsony cases
where market power is restricted by government law.
We will leave the details of the other market types and how they work for Economics 201.
In addition, the emphasis of this module is on markets, please note there are lots of examples
of production and exchange in the world that do NOT include markets.
Where relevant through this course we will note these situations, and adapt our analysis as
appropriate (although we will still use the economic tools of Marginal Benefit, Marginal Cost,
Incentives, opportunity cost, etc.)
2.2 A Simple Model of Consumer Demand
Let us think of the decision of an average consumer, trying to decide what to spend his/her
money on.
Suppose we are examining decision to buy some muffins, over a given time period like a day or a
We presume that an individual gets some pleasure or satisfaction or utility from consuming the
Economists then argue that individuals can translate this satisfaction into a monetary
equivalent, called the total benefit from consuming the amount of the good that is actually
This total benefit is the willingness to pay for so many units of the good, muffins in this
Finally, we can focus on your willingness to pay for one more muffin this willingness to pay for
one more unit is called the marginal benefit of consuming one more unit
2.2.1 An Individual's Demand Curve for Muffins
Economists argue that different individuals will each have a different willingness-to-pay for various
goods and services, depending on their personal income levels, and on their personal situations for
example, how hungry they are at 10 am in the morning.
Each individual will rationally compare their personal marginal benefit (MB) to the price of the
good in question, and will buy the good only if the MB is greater than the price.
Low price → MB > P for lots of people → the total demand is high.
As the price increases → now for more people P > MB → total market demand falls.
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