Transcript Ch 9 Price-taking model
Chapter 9 Price-taking Model
© Pilot Publishing Company Ltd. 2005
Contents:
•
• • • • • • • • •
Conditions of a Price-taking Market
Demand and Revenue Curves of a Price-taker
Equilibrium of a Wealth-Maximizing Firm
Efficiency and Price-taking Market
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Contents:
•
•
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Market
What is a market?
A
market
(
市場
) is a system governed by a set of rules or customs
under which a well-defined good is exchanged.
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Price-taking markets
A price-taker
: is a participant who
cannot affect the market price
has to take (accept) whatever price that the market determines.
• To a price-taker,
the market is a
price-taking market
or a
perfectly competitive market.
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Price-searching markets
A
price-searcher
: is a participant who
can affect the market price
has to search
for the wealth-maximizing price.
• To a price-searcher,
the market is a
price-searching market
or an
imperfectly competitive market © Pilot Publishing Company Ltd. 2005
Conditions of a Price-Taking Market
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Conditions of a price-taking market
1.
Large/Small
number of sellers 2.
Homogeneous/Heterogeneous
goods 3.
Perfect/Imperfect
information 4.
Free/Restricted
entry and exit
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Violation of conditions
The market with
only one seller
is a _________
.
The market
dominated by a few large sellers
is an The market with a large number of small sellers but
selling heterogeneous goods or having imperfect information
(Options: monopolistic competition / oligopoly / monopoly)
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Demand and Revenue Curves of a Price-taker
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Demand curve
A price-taker cannot influence the market price. The price is a constant irrespective of its quantity supplied. What is the shape of its demand curve?
$ d
The demand curve faced by a price-taker is
___________
at the prevailing market price.
0
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q
Q9.2: “As the demand curve faced by a price-taker is horizontal, the market demand curve, which is the horizontal sum of all individual demand curves, must also be horizontal.” Discuss.
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MR and AR curve
A price-taker cannot influence the market price. What will be the shape of its MR curve & AR curve?
$
Its MR curve and AR curve are at the prevailing market price. They
coincide with the demand curve.
(Options: vertical / horizontal)
MR = AR = d 0
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q
Equilibrium of a Wealth-maximizing Firm
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$
Derivation:
Loss Loss MC Output beyond q*: q*: MR Gain 0 q’
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q* q
$ 0
Equilibrium conditions
q’ Loss Gain Loss MC q*
Wealth-maximizing output © Pilot Publishing Company Ltd. 2005
MR q
1. MR = MC 2. MC curve cuts MR curve from below 3. In the short run, AR
AVC
and in the long run, AR
LRAC
Q9.3: (a) At q*, MR = MC. The marginal gain is zero. Explain why it is wealth-maximizing.
(b) At q’, MR = MC. Explain why it is not wealth maximizing.
(c) In the short run, if ATC > AR > AVC, explain why the output is still worth to be produced.
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Short-run Model
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Wealth-maximizing output level at a price below AVC Suspend production
$ The loss if suspend production = TFC = AFC^ x q^ = (ATC^ AVC^) x q^ ATC^ AVC^ P^
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0 q^ MC ATC AVC D^= MR^=AR^ q
Wealth-maximizing output level at a price equal to AVC
$ The loss if produce at q 0 = TFC = AFC 0 x q 0 = (ATC 0 AVC 0 ) x q 0 ATC P 0 = AVC 0 0
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0 q 0
Produce at q 0
MC ATC AVC d 0 = MR 0 = AR 0 q
Wealth-maximizing output level at a price above AVC but below ATC
$ The loss if produce at q 1 < TFC ATC 1 P 1 MC AVC 1 ATC d 1 = MR 1 =AR 1 AVC
Produce at q 1
0 q 1 q
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Wealth-maximizing output level at a price above ATC
$
MC The net receipt if produce at q 2 P 2 d 2 = MR 2 = AR 2
ATC
ATC 2
AVC
AVC 2
Produce at q 2 © Pilot Publishing Company Ltd. 2005
0
q 2
q
Short run supply curve of a price-taker
For P
<
min. AVC, Qs = 0 units. The supply curve
coincides with the y-axis
.
$ Supply Curve
For P
>
min. AVC, the supply curve
coincides with the MC curve
.
P 0 0
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q 0 ATC AVC q
Short run market supply curve of a price-taking industry
P P
P
P 1 s a
+
P 1 s b
… P 1
0 q a1 Firm a q a 0 q b1 Firm b
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q b
… 0 Q 1 Market S Q
Determination of the equilibrium price
$
P* S
The equilibrium price is determined by the
intersection point of the market demand and the market supply curves.
0
Q*
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D
Q
Long-run Model
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Long run adjustment 1. Producing at the output where MR equates LRMC
MR = LRMC LRMC curve cuts MR curve from below
$ P LRMC LRAC MR=AR
AR LRAC
0 q q
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$
2. Entry and exit until zero net receipt and production at the optimum scale are attained Positive Net Receipt
LRMC LRAC At q’ (MR = LRMC) AR’ > LRAC’ P’
MR’=AR’ Positive net receipt S
New firms enter & P
0 q’
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q
$ P’’ 0 Negative Net Receipt
q’’ LRMC LRAC At q’’ (MR = LRMC) AR’’ < LRAC’’ Negative net receipt MR’’=AR’’ Some firms leave. S
& P
q
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$
At q* (MR = LRMC),
AR* = LRAC* LRMC LRAC
* Zero net receipt
P* 0 q*
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MR*=AR*
No entry nor exit
q
Long run equilibrium
Long run market supply curve
In the long-run equilibrium,
P always equates the minimum LRAC
.
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Long run market supply curve
• The long-run market supply curve (relating P to Q) is
actually relating
the minimum LRAC to Q.
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Long run market supply curve
•
According to the relationship between LRAC and Q,
three kinds
of long-run market supply curves can be derived:
1. constant-cost 2. decreasing-cost 3. increasing-cost
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Long-run market supply curve
$ S1: Increasing-cost industry 0
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S2: Constant-cost industry S3: Decreasing-cost industry q
Number of firms in a price-taking market
P Number of identical firms in the industry =
Q d
/
q s
LRAC P* 0
q s Q d
D Q
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Q9.6: After an increase in market demand, predict what would happen to a price-taking industry in both the short run and the long run – number of firms, price, quantity supplied and net receipt.
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Efficiency & Price-taking Market
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Pareto efficiency
Pareto optimality or efficiency is attained if
it is
impossible
to reallocate resources
to make an individual gain (better off)
without making other individuals lose (worse off) © Pilot Publishing Company Ltd. 2005
Pareto efficiency
Inefficiency occurs if
it is
possible
to reallocate resources to
make an individual gain
(better off) without making other individuals lose (worse off).
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Allocation of resources involves three basic economic problems: 1. what to produce? 2. how to produce? 3. for whom to produce?
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Correspondingly, three efficiency conditions are defined: 1. production efficiency 2. consumption efficiency
3. allocative efficiency
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1. Production efficiency
– defining the criterion of “how to produce”
Production efficiency is attained when
goods are produced at the minimum cost.
then, it will be
impossible to raise the output of any good
without reducing the outputs of others .
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•
Conditions of production efficiency (production at the minimum cost):
All firms use cost-minimizing production methods to produce.
MCs
of all firms producing the same good
are equal
.
Why?
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2. Consumption efficiency
– defining the criterion of “for whom to produce”
Consumption efficiency is attained when
goods are
consumed by individuals with
the highest MUV.
then, it will be
impossible to raise TUV of any individual
without reducing TUVs of others.
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•
Conditions of consumption efficiency (consumption by individuals with the highest MUV):
MUVs
of all individuals consuming the same goods
are equal
.
Why?
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3. Allocative efficiency
– defining the criterion of “what to produce”
Allocative efficiency is attained when
resources are
allocated to their
highest-valued uses.
then, it will be
impossible to raise the TUV of all the commodities produced. © Pilot Publishing Company Ltd. 2005
•
Conditions to achieve allocative efficiency
(allocated to the highest-valued uses):
MUV
of each good is
equal to its MC Why?
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Situation in a price-taking industry:
Behaviours of producers
•
To maximize wealth, firms have to minimize cost. So they must
use the cost-minimizing production methods
in their production.
•
To maximize wealth, firms produce the output at which MC = MR = P. As they face the same price,
MCs
of all firms producing the same good
are equal.
Production efficiency is achieved.
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Situation in price-taking industry:
Behaviours of consumers
To maximize utility, individuals consume the amount at which MUV = P.
As individuals face the same market price,
MUVs
of all individuals consuming the same good
are equal
. Consumption efficiency is also achieved.
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Situation in price-taking industry:
Allocation of resources
Individuals consume the quantities where MUV = P.
Firms produce the quantities where MC = P.
As they face the same market price, MUV = P = MC.
Allocative efficiency is achieved.
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Situation in price-taking industry:
Conclusion:
•
In price-taking markets, resource allocation is
efficient.
•
This is achieved without any government intervention nor guidance from visible hands.
•
Individuals & firms make their own decisions
according to the market price (the invisible hand) adjusted under the market mechanism.
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Appendix I: “Perfect competition” is a misleading term (as if other markets are less competitive)
1. Under scarcity & maximization
“severe” competition exists in all kinds of markets e.g.,
monopoly
--- compete for the monopoly right, against potential entrants, against takeover, with producers of substitutes, factor suppliers and consumers, etc.
2. “Price-taking” is a more appropriate term
since individual sellers
cannot affect
the price.
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Appendix II: Supply
A. Quantity supplied and supply
•
Quantity supplied
is the amount that a supplier is willing and able to sell at a certain price within a certain period of time.
at different prices , the supplier is willing to sell different quantities
.
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Appendix II: Supply
A. Quantity supplied and supply
•
Supply
describes the relationship between the price and the quantity supplied of a good.
if expressed in the form of a table
---
if expressed in the form of a curve
---
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1. Price of a variable factor
P
Price of variable factor
S’(=
MC’)
P
MC
S(=
MC) S
Price of variable factor
S(=
MC) S
S’(=
MC’) MC
0
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Q 0 Q
P
2. State of technology
S S(= MC)
Technology improvement
S’(= MC’) MC Q 0
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3. Tax
P
S
S’(=
MC’)
MC
S(=
MC)
Imposition of a sales tax
q 0
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P
4. Subsidy
S
S(=
MC)
Imposition of a subsidy S’(=
MC’ ) MC
0
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q
5. Price expectation
P S
S’(=
MC’) S(=
MC)
Supplier expect the future price
q
Present supply
Why?
0
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6. Weather and climate
P
S
S’(=
MC’) S(=
MC)
Bad weather e.g. a typhoon
S of vegetables
q 0
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7. Price of related goods (joint supply)
Pork P x S x P Y Pork chop S Y1 P x2 S Y2 P x1 0 X 1 X 2 X 0
Why?
Y
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P x P x2
8. Price of related goods (competitive supply)
Fruits S x
P
Y Vegetables S Y2 S Y1 P x1
0 X 1
X 2
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X 0
Why?
Y
Appendix III: Elasticity of Supply A. What is elasticity of supply?
Price elasticity of supply
( p E s ) is a measure of the
responsiveness
of the
quantity supplied
of a good to
a change in its price.
p E s % in quantity supplied % in price
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2. According to the size of elasticity Perfectly inelastic Inelastic Unitarily elastic Elastic Perfectly elastic Es = 0 Es < 1 Es = 1 Es > 1 %Δin quantity supplied of X
= 0
%Δin X
<
%
in P %Δin X
=
%
in P %Δin X
>
%
in P Es = infinity %Δin X
= infinity © Pilot Publishing Company Ltd. 2005
B.Classification of price elasticities of supply
1. According to the formula adopted in calculation
Point elasticity of supply
applied when the %
Δ
is very small
Arc elasticity of supply
applied when the %
Δ
is not very small
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Point elasticity of supply-- non-linear supply curve
P 1 P A
S
Δ
P x
Mathematical measure:
X
P
P
1
X
1 Δ
X
C Tangent at point A B O X 1 X
Graphical measure:
p E s at point A: AB AC P 1 O P 1 C X 1 B X 1 O
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Point elasticity of supply -- linear supply curve
P P 1 A
S
Δ
P x
Mathematical measure:
X
P
P
1
X
1 Δ
X
B C O X 1 X
Graphical measure:
p E s at point A: AB AC P 1 O P 1 C X 1 B X 1 O
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Q9.8: The supply of new residential flats is inelastic. List all possible reasons.
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Determinants of elasticity of supply
1. Flexibility of production
Production method Mobility of factors
Production time required 2. Time for adjustment 3. Ease of entry and exit 4. Size of stock 5. Ease of storage
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Advanced Material 9.1
Equilibrium by TR curve and TC curve
$
Short run
Slope = MR TC TR Largest net receipt
Equilibrium by TR and TC curves
$
TR
Long run
MR
The largest net receipt
MC 2
At q 1 , MR>MC 1 ,
production raises net receipt.
At q 2 , MR
0
MC q 1 1
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q* MC*
q
At q*, MR=MC*, net receipt is the largest.
q 2
Wealth-maximizing output
Advanced Material 9.2
Marginal firms and infra-marginal firms
1. Absorption of net receipts by superior factors
$ P 0
Original net receipt
LRMC
LRAC’ (under competition, factor incomes of superior factors rise and absorb the original net receipt)
LRAC q
An established firm with superior factors
q 0
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2. Classification of firms according to their responses to a fall in price
Marginal firms
do not have superior factors
and they
leave
the industry even if the
market price falls by a very small amount
.
Infra-marginal firms
have superior factors
and they
leave
the industry only if the market price falls drastically.
(Options: Marginal firms / Infra-marginal firms) © Pilot Publishing Company Ltd. 2005
3. When price falls, some firms instead of all will leave
Price some firms leave reaches the mini. LRAC supply price remaining firms can stay until it
4. The first firm to leave 1.
If resources are
heterogeneous
,
marginal firms
be the first to leave. would
2.
If resources are
homogeneous
, which firm will leave first is
by random selection
.
(Options: homogeneous / heterogeneous) © Pilot Publishing Company Ltd. 2005
Correcting Misconceptions: 1. The market demand curve faced by a price taking industry is horizontal. 2. The short-run supply curve of a price-taker is its MC curve.
3. The equilibrium condition of a wealth maximizing firm is TR = TC.
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Correcting Misconceptions: 4. If a firm earns zero net receipt (profit), it is not worth to produce.
5. As infra-marginal firms have superior factors and lower production costs, they have positive net receipts even in the long run.
6. When market price falls, all existing firms suffer losses and they will leave the industry.
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Correcting Misconceptions: 7. After the imposition of a lump-sum tax, a price-taker will cut its output both in the short run and the long run.
8. Efficiency is attained if it is impossible to reallocate resources to make an individual gain.
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Survival Kit in Exam
Question 9.1 : Explain why the equilibrium of a price-taking industry is efficient. Use a demand-supply diagram to explain.
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