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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
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Willingness to pay is determined by
Buyer¶s tastes or needs
Income and wealth Normal/inferior goods
Cyclical/acyclical demand
Substitutes
Complementary goods
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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
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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?
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Market segments / Price discrimination
Different segments willing to pay different prices
Consumer surplus Can firms exploit this?
Feasible?
Fair?
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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
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Time-frame: easier to
find substitutes over
long run
Demand curves
Accept as given?
Seek to modify?
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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?
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Short run supply
Based on costs
Fixed costs: incurred regardless of volume
µheadquarter¶ 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 (?)
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Marginal costs
Cash costs: out-of-
pocket
Opportunity costs:foregone profits
Marginal cost curve :
Short run supply curve
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Long run supply: entry & exit
Recover both fixed and variable costs
Fixed costs Out-of-pocket costs
Opportunity costs: return on capital
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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
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Market equilibrium
Interesection of marketdemand and supply curves
Disequilibrium will cause price to adjust and yield
new equilibrium
Real world: series of smalldisequilibriums, series of
price adjustments
Currency markets: rapid,continuous adjustments
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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
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Profit calculation based on equilibrium price
Average and marginalcosts
Marginal costdetermines supply
volume Average costs at that
volume
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Market adjustment
Shifts in demand and supply curves
Increase: shift to the right
Decrease: shift to the left
Impact on quantity and price
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Inelastic curves: adjustment largely through price
Elastic curves: adjustment largely through quantity
Short run versus long run
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Perfect competition
Three assumptions:
1. Identical products
2.M
any small price-taking buyers and sellers3. Full information
Excess profits more firms enter
increased supply lower price zero
excess profits
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Three more
conditions:
1. Identical sellers
2. Free entry
3. Free exit
Zero excess profits
Long run profitability?
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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
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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
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Differences among
sellers
Least cost producer
Innovation
Imperfect information
Search costs protect
existing relations and
discourage competition