Impacts of supply and demand shifts

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conom

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Impacts of supply and demand shifts

LESE204

Depart

ment of

Food a

nd R

esourc

e E

conom

ics

1. Impacts of Supply shift

P

Q

D

Elastic Demand

P

Q

D

Inelastic demand

Same size of shift

SS’S S’

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2. Impacts of Demand shift

P

Q

D

Elastic Supply

P

Q

D

Inelastic demand

Same size of shift

D’

D

D’

SS

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3. Impacts of Supply and Demand shifts

P

Q

D

Pork Market

P

Q

Beef Market

D

D’

S

S

Source: Norwood and Lusk, Ch 3.

Environmental regulation on pork producers

S’

ep

ep’

ep’’

eb

eb’

Partial equilibrium: ep ep’

General equilibrium: ep ep’’ in pork market,

eb eb’ in beef market

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Supply in a competitive market

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Assumptions and implications

■ Assumptions

- Many buyers and sellers.

- Product is homogeneous (identical).

- Perfect information is provided

- No transaction costs.

-Free entry and exit.

■ Implications

Firms (suppliers) are price takers

iiiiai FCQCQP )(

)( iia QmcP

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Representative firm’s decision

$

Q

AC

AVC

MC

Pa = MR

Q*

AC

Pa

Profit = (P - AC) Q*

operating loss / profit determining the short-run supply

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Imperfect competition

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1. Addressing the issues

Market?

-Single supplier & numerous consumers

- A few suppliers & numerous consumers

- Numerous suppliers & single buyer

- Numerous suppliers & a few buyers

- Single supplier & single buyer

- A few suppliers & A few buyers

The extent of competition is a key point

Sellers BuyersCompetition

among sellersCompetition

among buyersCompetition

The competition generally depends on the number of sellers or buyers

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- Competition among players and channels

Farmers Wholesalers

Food company

Retailers

Super chains

Big Marts

Food company

Middle men

(Wholesalers)

Big Marts

assemblers

assemblers

Retailers

C

O

N

S

U

M

E

R

SFarmers

Farmers

Farmers

Farmers

Farmers

Farmers

Farmers

cooperatives

There also exist competition among players at a same stage of marketing channel. (Pfa > ? < Pfc )

Competition among channels exist. (Pf1 > ? < Pf2 / Pr1 > ? < Pr2 )

Retailers

Pf1

Pr1

Pf2

Pr2

Pfa

Pfc

C

O

M

P

E

T

I

T

I

O

N

C

O

M

P

E

T

I

T

I

O

N

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1. Addressing the issues

Definition of marketing

an integrated process through

which

companies (player)

create value for customers

and (function)

build strong customer relationships

(tool)

in order to capture value from

customers in return.

Several ways of capturing the value

- Advertising

- New product

- Cost Reducing

- New technology

Tools that enable the players to win at the

competition

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2. Monopoly

Main reason that causes monopoly is barriers to entry

- Exclusive right to use a key resource.

- Exclusive right to produce some good

- Costs of production make a single producer more efficient than a large number of

producers Natural monopoly

P

Q

AC(average cost)

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2. Monopoly

■ Demand Curve that is faced by monopolistWhole market demand is the one that monopolist faces

However, in a competitive market, an individual supplier faces a horizontal demand

curve

P

Q

D

P

Q

S

D

P*

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2. Monopoly

■ Profit Maximization Whole market demand is the one that monopolist faces

MR = MC

However, in a competitive market, an individual supplier faces a horizontal demand

curve

P = MC

P

QD

iiiii FCQCQQP )()(

iiiii FCQCPQ )(

MR

AC

MC

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2. Monopoly

Marginal revenue and marginal cost

Q = 10-1/2 P TR : PQ = 20Q -2Q*Q

MR= 20-4Q

Cost C(Q) = 2Q+Q*Q + 10 MC = 2+2Q

Total Profits = 20*3+2*3*3 – (2*3+3*3 +10) = 17

P

Q

20

10

10

5

16

4

14

8

2 3 6 8

Marginal Revenue

Eq,p = - 16

Eq,p = -

Eq,p = - 2.3

Eq,p = - 1

Eq,p = - 0.67

Eq,p = - 0.25

Eq,p = 0

Q

20

10

10

5

16

4

14

8

2 3 6 8

Eq,p = - 16

Eq,p = -

Eq,p = - 2.3

Eq,p = - 1

Eq,p = - 0.67

Eq,p = - 0.25

Eq,p = 0

MR

MC

2

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2. Monopoly

■ Profit Maximization

Foc:

MR MCPrice-cost margin(Lerner-index)

0 ≤ L ≤ 1 : if L > 0 existence of market power

At the monopoly price, Eq,p ≤ -1

iiiii FCQCQQP )()(

0)()(

)(

0)(])([

Q

QCQ

Q

QPQP

Q

FC

Q

QC

Q

QQP

Q

pqEP

Q

Q

QP

P

mcPL

,

1)(

QQ

QPQmcQP

)()()(

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2. Monopoly

■ Price discrimination: charging different customers different prices

<Examples of Price Discrimination>

Movie tickets

Airline prices

Discount coupons

Quantity discounts

1. first degree price discrimination:

price varies by customer's willingness

2. second degree price discrimination:price varies by quantity sold. Larger quantities are available at a lower unit price.

3. Third degree price discrimination:price varies by attributes (according to market segments)

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2. Monopoly

■ first degree price discrimination:

Pm

Q

D

MC

MR

P

QmQc

Consumer surplus under Pm

Variable profits of monopolist

under Pm

additional profits of monopolist

under perfect price discrimination

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2. Monopoly

■ Second degree price discrimination:

Pm

Q

D

AC

MR

P

Qm

Q1

MC

P1

P2

P3

Q3Q2

< +

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2. Monopoly

■ Third degree price discrimination

Foc:

)()()( QCQQPQQP bbaa

0)(])([

0)(])([

bb

bb

b

aa

aa

a

Q

QC

Q

QQP

Q

Q

QC

Q

QQP

Q

MCMRa

QQQ ba

MCMRb

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2. Monopoly

■ Third degree price discriminationMarket segmentation

The term is used when consumers with identical product and/or service

needs are divided up into groups so they can be charged different prices.

Market segment meets all of the following criteria:

- it is distinct from other segments (different segments have different

needs),

- it is homogeneous within the segment (exhibits common needs);

- it responds similarly to a market stimulus,

- it can be reached by a market intervention. (source: Wikipedia)

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2. Monopoly

Pm1

■ Third degree Price discrimination

Market 1 Market 2 Aggregate demand

D1MR1

D2MR2

Da

MRa

MC

Pm2

In a market where demand is more elastic, charge a lower price

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3. Monopolistic Competition

■Monopolistic competition

- Many firms sell the products that are not identical (but similar products are sold

by competing firms).

Product differentiation:

Individual firm faces a downward-sloping demand curve,

- Free Entry or Exit: Firms can enter or exit the market.

Firms enter the market until economic profits are zero.

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■Monopoly v.s. Monopolistic competition

Lm > Lc

Monopoly Monopolistic competition

Market power

(L = (P-mc)/P)

Lm > 0 L c> 0

Perception of the

demand

Market demand =

perceived demand

Perceived demand =

some portion of the whole

market demand

(downward slopping)

Entry and Exit No additional entry Free

Existence of

Other brand

No Many demand is more

elastic than monopoly

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■ Short run – firm gets the profits

P

Q

MC

D: faced by individual firm

AC

MR

Profit

encourage new firms to enter

the market

reduce the demand of

existing firms

demand curves of

existing firms shift to the left

Optimal quantity of incumbent

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■ long run – firm gets no profits

P

Q

MC

D: faced by individual firm

AC

MR

Profit

new firms will enter

until the profits of existing firms become zero

Optimal quantity of incumbent

D’

MR’

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■ long run – firm gets no profits

P

Q

MC

AC

MR

D’

MR’

Excess Profits exist

P* > MC

P*

Over capacity

Q* < Qc

Qc: quantity produced at efficient scale

Qc

Q*

Pc

ACMC

= MR

Qc

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■ Social welfare of monopolistic competition

deadweight loss of monopoly pricing in monopolistic competition

exists because of the markup of price over marginal cost.

P

Q

MC

AC

MR

D’

MR’

P*

Qc

Q*

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3. Monopolistic Competition■Ways to differentiate

1. Advertise

In a monopolistic competition, each firm has an incentive to advertise

Effects of advertisement

i) Increase the competition by offering many kinds of brands or prices

ii) Give a signal to the consumers that the firm provides a higher

quality of product

“Brand” name (in the context of signaling)

offers consumers the information about the quality

gives an incentive firms to maintain high quality

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■Ways to differentiate

1. Advertise

How much advertisement is optimal?

Marginal revenue from advertising = Marginal cost for advertising

advertising-to-sales ratio = the ratio of the advertising elasticity of

demand to the own-price elasticity of demand.

: Steiner-Dorfman condition

At larger advertising elasticity, greater advertising-to-sales ratio

PQ

AQ

E

E

R

A

,

,

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AAPQCPAPQ )),((),(

0

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P

P

CP

P

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PQ

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,

foc:

Under perfect competition, p-mc =0 no incentive to advertise

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Impacts of supply and demand shifts

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