P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 1 Session 6 • Applications of Perfect Competition Perfect competition with real firms 1 Topic 3 Topic 4 Topic 5 Isolate entry/exit Isolate quantity Combine entry/exit & quantity How Fix size of a firm, Fix which firms are in the market, Firms decide both whether to enter only decision is whether to enter only decision is how much to prod. and how much to produce Individual Entry ← break-even price Quantity ← MC Entry ← AC firm (economic cost) Quantity ← MC € MC i ↔ Supply i € MC Re-interpret unit supply from 50 Sessions 1 & 2 as entry 40 40 AC 30 AC u 20 20 10 Q i Q 10 20 30 5 10 15 20 25 30 35 Q u Aggregate Supply goes up via Supply goes up via expansion Supply goes up via entry supply entry of new firms of output by firms in market and expansion of firms in market $ 45 € MC ↔ Supply 40 P MC ↔ supply 30 35 25 30 40 25 20 20 15 15 20 10 10 5 5 Q 5 10 15 20 25 30 Q 100 200 300 400 Q (100MW) 100 200 300 This picture always holds 2 $ Consumer surplus MC ↔ Supply P ∗ → 35 Producer MV ↔ Demand surplus Q ∗ → 50 Q
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 2 Session 6 • Applications of Perfect Competition 6. Applications of Perfect Competition 3 1. Market dynamics. ➥ 2. Simulation results. 3. Bagels and Cranberries (“Growth and Profitability”). Long-run dynamics 4 $ 60 S long 50 P ∗ 2 → 40 P ∗ 1 → 30 20 D 2 10 D 1 10 20 30 40 50 60 70 80 90 Q
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 3 Session 6 • Applications of Perfect Competition Firms’ short-run responses to price changes 5 $ 60 S long 50 40 P ∗ 1 → 30 20 10 D 1 10 20 30 40 50 60 70 80 90 Q Short-run vs. long-run price adjustment 6 $ S short 60 S long 50 40 30 20 D 2 10 D 1 10 20 30 40 50 60 70 80 90 Q
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 4 Session 6 • Applications of Perfect Competition Bottom line 7 Whatever the source of adjustment delays and costs: Adjustment delays and costs imply that supply adjusts less in the short run than in the long run—hence, prices are more volatile in the short run than in the long run. Interpreted as delays for entry 8 $ S short 60 S long 50 40 30 20 D 2 10 D 1 10 20 30 40 50 60 70 80 90 Q
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 5 Session 6 • Applications of Perfect Competition Price and capacity dynamics in a competitive industry 9 ������ ���������������������� ����� �������� � � ����� � � � � � � � ����� � � � � � � � � � � � � � � � � � ����� � � � � � � � � � � � � � � � � � ����� � � � � � � � � � �������� � � � � ��������� � ��������� ���������� ���� ������ ����� � �� ����� � �� ����� ��� � ��������������������������� ��������������������������� �������� ������� ���������������� �������� ��������� ���������������� ���� �������������������� �������������������� ��������������������� ��������������������� � ���������������������� � ��������������������� �� (Courtesy of David Besanko.) Bulk shipping 10 Bulk shipping: vessels designed to carry a homogeneous unpacked dry or liquid cargo, for individual shippers on non-scheduled routes. • Common cargo: iron ore, grain, coal, bauxite, phosphates, steel, cement, sugar, wood chips. • “Taxis, not buses”. (Entire cargo belongs to one shipper.) • 72% of world seaborn trade (by weight). (Data is thanks to Myrto Kaloupsidi.)
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 6 Session 6 • Applications of Perfect Competition Market structure 11 Shipping prices 12
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 7 Session 6 • Applications of Perfect Competition Demand volatility 13 Maarket is characterized by demand volatility due to changing export patterns, macroeconomic cycles. Elasticity 14 1. Transportation costs are a small portion of total cost for most goods (e.g. for gasoline $0.07 per gallon). 2. Few short-run substitutes. 3. Disruptions are costly: • “Just-in-time” inventory models • “Continuous-flow” refining So what?
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 8 Session 6 • Applications of Perfect Competition Demand volatility 15 Demand: inelastic and volatile + Supply: inelastic ⇓ Volatile prices 6. Applications of Perfect Competition 16 ✓ 1. Market dynamics. ➥ 2. Simulation results. 3. Bagels and Cranberries (“Growth and Profitability”).
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 9 Session 6 • Applications of Perfect Competition 6. Applications of Perfect Competition 17 1. Market dynamics. ✓ ✓ 2. Simulation results. ➥ 3. Bagels and Cranberries (“Growth and Profitability”). 6. Applications of Perfect Competition 18 ✓ 1. Market dynamics. ✓ 2. Simulation results. ✓ 3. Bagels and Cranberries (“Growth and Profitability”).
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 10 Session 6 • Applications of Perfect Competition This week 19 (Wed) Session 7: Elasticity of demand • Prep Guide 8. • FPM Ch. 8. • A demand estimation exercise to hand in. (Fri) Session 8: Pricing with Market Power • Prep Guide 7. • FPM Ch. 7. Reminder: Next week you have … 20 … optional review and quiz . Monday Tuesday Wednesday Thursday Friday Session 9 Review Quiz Session 10 – Quiz covers only up through Session 8.
Total cost: One way to approach your task in rounds 1 and 2: € 1. Predict a market price P . 10000 c ( Q ) 2. Decide how much to produce at this price: s i ( P ) . 3. Back out inputs needed to produce this amount. 5000 Supply curve? Derive from cost curve. Cost curve? Derive from production function. Q 100 200 300 Marginal cost / Supply: Individual firm: € 90 f ( L , M ) = L 1 / 3 M 1 / 3 Production function: ⇓ 60 c ( Q ) = 2 Q 3 / 2 Derive cost curve: ⇓ mc ( Q ) , s i ( P ) mc ( Q ) = 3 Q 1 / 2 Marginal cost: 30 ⇓ s i ( P ) = P 2 / 9 Inverse is supply curve: Q 100 200 300
Higher level question – how to predict P ? Forecasts Individual Market supply price Aggregate supply Equilibrium: s ( P ) = d ( P ) . Supply / Demand / Equilibrium: Equilibrium: € s ( P ) = 39 9 P 2 Total supply: 39 × s i ( P ) ⇒ 90 P ∗ = 27.42 Equil. solves: s ( P ) = d ( P ) ⇒ 60 s ( P ) Back to you: 30 You choose: Q i = s i ( P ∗ ) Q i = 83.5 ⇒ d ( P ) Back out inputs: from f L = M = 763.5 ⇒ Q 3000 6000 9000
Following the shift in demand … Short-run problem (Round 3): Machines are fixed at their round-2 level. Long-run problem (Rounds 4, 5): Both inputs are adjustable. New Long-run Equilibrium: Long-run adjustment: € New demand: d new ( P ) = 8970 − 100 P 90 New long-run Equilibrium: equilibrium s ( P ) = d new ( P ) ⇒ P new = 35.40 60 s ( P ) Back to you: 30 You choose: Q i = s i ( P new ) ⇒ Q i = 5430 d new ( P ) d ( P ) Back out inputs: from f L 4 = M 4 = 1643 ⇒ Q 3000 6000 9000
Short-run production (round 3): Total cost: € 10000 Stuck with: M curr = 763.5 c ( Q ) � c ( Q ) Q = L 1 / 3 M 1 / 3 Short-run prod. function curr � �� � 5000 invert ⇓ Q 3 Labor requirements: L = M curr Q 100 200 300 Short-run costs (round 3): Marginal cost / Supply: ( � = short-run values) c ( Q ) = M curr + Q 3 € Total cost: � 90 M curr mc s ( Q ) , � � s i ( P ) short-run short-run fixed cost variable cost 60 3 Q 2 Marginal cost: � mc ( Q ) = mc ( Q ) , s i ( P ) M curr 30 (Invert P = MC ) ⇓ � M curr Supply: � s i ( Q ) = P 3 Q 100 200 300
Short-run equilibrium: Short-run equilibrium (round 3): € Total supply: s ( P ) = 39 × � ˆ s i ( P ) � 90 s ( P ) Short-run � equilibrium Equilibrium: � s ( P ) = d new ( P ) P = 47.03 ⇒ 60 Back to you: 30 � s i ( � � You choose: Q i = � P ) Q i = 109.4 ⇒ d new ( P ) d ( P ) Back out inputs: from f L 3 = 1715 ⇒ Q 3000 6000 9000 Short-run and Long-run Equilibria: € � s ( P ) 90 60 s ( P ) 30 d new ( P ) d ( P ) Q 3000 6000 9000
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