P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 1 Session R1 • Midterm Review Midterm review 1 1. Some sample quiz questions ➥ 2. Some ideas on elasticity of demand 3. An exercise on (a) medium run and (b) long run Sample quiz question 2 Which of the following hold (in equilibrium) for an individual firm in the model of perfect competition? a. Its marginal revenue is less than the market price. b. It never earns an economic profit. c. Its marginal cost equals its marginal revenue.
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 2 Session R1 • Midterm Review Sample quiz question 3 Which statements about the inefficiency of the decisions of a firm with market power are true, in the models we have studied? a. The firm has no incentive to reduce its cost of production. b. The firm will produce too much in order to take over market share. c. The firm may forgo projects that have positive net social value. Midterm review 4 ✓ 1. Some sample quiz questions ➥ 2. Some ideas on elasticity of demand 3. An exercise on (a) medium run and (b) long run
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 3 Session R1 • Midterm Review From “Exercise on Scenario 5 Demand and Elasticity” Product category: Passenger jets. Dominated by two firms: Airbus (A) and Boeing (B). (For simplicity, imagine that each firm produces one kind of jet, and these two jets make up the entire product category.) Hypothetical demand functions: Q A = 60 − 3 P A + 2 P B Q B = 60 − 3 P B + 2 P A Find Airbus’ elasticity at P A = 24 … 6 when Boeing’s price is P B = 30 : And when P B = 24 ?
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 4 Session R1 • Midterm Review Illustrate graphically 7 Graph Airbus’ demand curve when P B = 24 and when P B = 30 : P i 40 30 20 10 30 60 90 120 Q i Market demand 8 Market demand: How does aggregate demand for the entire product category respond when the prices of all products in the category go up? Aggregation problem: Need to define … Q A = 60 − 3 P A + 2 P B Q B = 60 − 3 P B + 2 P A • aggregate output • a price index Our numerical example is easy. We can just add the two quantities: Q = Q A + Q B For a price index, we use the average price: P = P A + P B 2
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 5 Session R1 • Midterm Review Aggregation: Calculation 9 Aggregate demand Q as a function of the average price P ? Q A = 60 − 3 P A + 2 P B Q B = 60 − 3 P B + 2 P A Q A + Q B = (60 − 3 P A + 2 P B ) + (60 − 3 P B + 2 P A ) = 120 − P A − P B � P A + P B � = 120 − 2 ⇒ Q = 120 − 2 P 2 � �� � � �� � Q P Summary: Market demand versus Airbus’ demand 10 MARKET DEMAND AIRBUS’ DEMAND (If P B = 24 ) Q = 120 − 2 P Q A = 108 − 3 P A P P i 60 60 50 50 40 40 30 30 20 20 10 10 30 60 90 120 30 60 90 120 Q Q i (From slide 18) (From slides 15 & 16)
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 6 Session R1 • Midterm Review Comparing the elasticities 11 Calculate the elasticity of the market demand curve at P = 24 : From Q = 120 − 2 P , choke price is ¯ P = 60 : 60 − 24 = 24 24 36 = 0.67 E = = ⇒ It is much lower than the elasticity of Airbus’ demand curve at P A = 24 , given P B = 24 . Intuition? Broader idea 12 This illustrates a broader idea brought up in Session 3: The more we aggregate across products, the less elastic is demand. For example: demand for computer monitors less elastic than demand for LCD monitors less elastic than demand for Acer LCD monitors less elastic than demand for the Acer AL1916 19” widescreen monitor
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 7 Session R1 • Midterm Review Midterm review 13 1. Some sample quiz questions ✓ ✓ 2. Some ideas on elasticity of demand ➥ 3. An exercise on (a) medium run and (b) long run Falafel vendors on the beach of Lebanon 14 E h c a e C B D F J I A G H K B
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 8 Session R1 • Midterm Review An illustration of these ideas … for perfect competition 15 1. For individual firm: • Supply decision, when in market, depends only on marginal cost. • Fixed cost drives exit/entry decision. 2. But at level of the market (equilibrium) Fixed costs ⇒ exit/entry decisions ⇒ market prices How we do this 16 For case of identical firms (free entry) … Study adjustments following a shift in demand: Long run given initial demand curve. 1 2 Medium run after shift in demand. Long run after shift in demand. 3 (We did this in Session 6 for an increase in fixed cost.)
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 9 Session R1 • Midterm Review A falafel vendor on the beach of Lebanon 17 Typical cost structure: Lira (100s) 28 24 20 MC 16 12 AC 8 4 100 200 300 Q Assume free entry 18 Draw approx. aggregate supply curve and show equilibrium. Lira (100s) Demand: Q = 3000 − 100 P 28 24 20 16 12 8 4 1000 2000 3000 Q
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 10 Session R1 • Midterm Review So find equilibrium … 19 (a) Q ∗ i (b) P ∗ (c) Q ∗ (d) N ∗ How we do this 20 For case of identical firms (free entry) … Study adjustments following a shift in demand: ✓ Long run given initial demand curve. 1 2 Medium run after shift in demand. Long run after shift in demand. ➥ 3
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 11 Session R1 • Midterm Review But then demand fluctuates 21 How does long-run equilibrium change? Lira (100s) 28 24 20 16 12 8 4 1000 2000 3000 Q So find (long-run) equilibria … 22 (a) Q ∗ i (b) P ∗ (c) Q ∗ (d) N ∗
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 12 Session R1 • Midterm Review How we do this 23 For case of identical firms (free entry) … Study adjustments following a shift in demand: ✓ 1 Long run given initial demand curve. ➥ Medium run after shift in demand. 2 ✓ Long run after shift in demand. 3 But suppose entry and exit take time … 24 Think of long run as after exit/entry; medium run is before exit/entry. What are medium-run supply decisions and equilibrium??
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 13 Session R1 • Midterm Review What is Of an individual vendor? 25 medium-run supply? Lira (100s) 28 24 20 MC 16 12 AC 8 4 100 200 300 Q What is Of the entire market? 26 medium-run supply? Lira (100s) 28 24 20 16 12 8 4 1000 2000 3000 Q
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