Economics summary sheet Test 2

Market equilibrium occurs at the intersection of the demand and supply

curve
Goods supplied by the producers = goods demanded by the consumers

Equilibrium:

All buyers and sellers are satisfied with their respective quantities at the
market price
Nobody has any incentive to change
Optimal economic position

When both supply and demand curve shift to the right the equilibrium price
may rise, fall or remain unchanged

Equilibrium and the perfectly competitive market:

In a perfectly competitive market the supply and demand curves measure the
marginal cost of producing the product and the reservation price for consuming
the product.
Impact on the equilibrium price and quantity when there is an increase in the
marginal cost of production of all firms:

An increase in marginal cost means you produce less units of goods as P =

MC
Will cause the aggregate supply curve to move to the left a price rise
and demand drop to reach equilibrium again
May cause some firms to leave in the short run or the long run if the
marginal cost shift puts it below the average variable cost or average total
cost

Surplus:

Buyers surplus: difference between the buyers

reservation price and what they actually pay
Sellers surplus: difference between the price
received by the seller and his/her reservation
price
Total surplus: Sum of buyers and sellers
surplus
Perfectly competitive market has reached
equilibrium total economic surplus is maximised

Pareto efficiency

If there is no opportunity for exchange or trade that will make at least one
person better off without harming other
Pareto improving transaction transaction that leaves one person better
off without harming others

Efficiency as a goal

It is important to realize that efficiency is not the only goal ACCESS is a

goal as well
We try to make the market as efficient as possible as surplus is maximised
which in turn allows us to pursue other goals more easily

The invisible hand effect:

Consider a condition where condition where economic profit is being

made. In the short run, the market is working at equilibrium and earning a
positive economic profit.
When you produce at P = MC (positive profit selling more than
opportunity cost)
People enter the market as profit is being made

Supply curve shifts to the right and there is a new equilibrium price and
significantly lower economic profit
People stop entering when P = minimum value of the ATC

As profit maximising occurs at P = MC and now MC = Min value of ATC, economic

profit is zero and staying/ leaving are both equally appealing Nobody moves
This concept can also work in reverse.

Firm experiencing economic loss people leave supply curve shifts to

the left
More profit is made until profit is zero

Government Intervention and

trade

Excess Demand:

Assume price is decreased to P1

The supplier wants to supply less
moves to QS
At QS, the price has fallen more people
demand it (QD)
QD want to buy it but there is only QS
avaliable Shortage

Excess Supply:

Assume price is forced up from PE to P1

Supplier wants to supply more, hence
moves to QS
At QS, only QD is demanded
Hence there is excess supply as
represented by the purple traingle

Consumer and producer surplus at a price ceiling:

Consumer surplus increases

Producer surplus decreases
Overall loss of surplus = deadweight loss

Pareto improving transaction:

It is important to note that these situations are not efficient. They are
similar in the fact that the quantity exchanged is below equilibrium

Main driver in who pays the tax:

Elasticity
More elastic = shift to the buyer

Taxes are justified if their goods exceeds the dead weight loss

Main effect determining deadweight loss:

Elasticity
Less elastic = less loss
Consumers bear more as steepness increases
Consumption behaviour is less likely to change from a tax introduction so
they consume close to pre-tax levels

Price Subsidies:

A subsidy pushes the price down to P1

Consumer surplus increases
The government spends money for each unit to bring the price down
Subsidies are good as it allows more people to get access to the good.
However it is important to note that the government is spending $X in
order to get less in $X in benefit.

Monopoly

Pure monopoly: single firm is the sole supplier of a product for which there
are no substitutes
Oligopoly: a market in which there are only a few rival firms producing
goods that are close substitutes

Monopolistic Competition

Large number of firms produce slightly differentiated products that are

reasonably close substitutes for one another.
Often differentiated on loaction and ancillary services. Eg Petrol stations

Aspect of perfect competition that monopolies break:

Price takers violated as they can set their own price

Barriers to entry one firm is allowed to dominate

Individual firm demand curve

Perfectly competitive
All firms are price takers people will demand at the market price from all
firms
No incentive to change price firms supply along the line

Imperfectly competitive

When firms change the price, they lose some business

Closer to monopoly = closer to what is a perfectly competitive market
demand curve
Monopolies are the market

Market power:

Ability to change price without losing sales

Monopolies have the greatest market power, however this power is never
absolute. This is due to the fact that monopolies still interact with
economic agents that have reservation prices
Only exception perfectly inelastic goods
(You wont charge $1000 for one apple)

How do these markets arise? Barriers to entry!

Exclusive control over important output

Governemt created monopolies patents
Network economies Facebook the more people consuming the product,
the more value it as to the consumer

Also- Economies of scale

Constant returns on sale increases all factors of production by a scale

and the outputs increase by the same scale
Increasing returns to sale increases all factors of production by a scale
and outputs increase by MORE than this

As one firm develops economies of scale becomes more efficient than other
firms hence can offer lower marginal cost and lower price so consumers come
to that firm creates natural monopoly

Profit maximisation rule in monopolies

Set quantity where Marginal revenue = marginal cost
Refer to slides

Competition Law:

The purpose of the competition law is to foster market competition by

regulating the anti-competitive conduct of firms

Average Cost pricing Policy:

A policy through which the government forces the monopolist to set the
price and quantity at the intersection of the Average Total cost curve and
the demand curve

This policy has many side effects and eliminates any positive profit accured to
the monopolist as:

The government does not know the ATC

No incentive to invest in technology no innovation
Allocatively inefficient

Making monopolies more efficient:

Monopolies can try to achieve this using various techniques of price
discrimination
the practice of charging different buyers different prices for essentially the
same good or service, where the differences do not simply reflect differences in
cost of supplying different buyers
First degree price discrimination when the monopolist knows the
reservation price of every consumer and charges them that
Problems associated with this:

Very hard to actually determine ever single reservation price

Cant sell to different people for different prices (legality issues)
In this situation there is no deadweight loss as they charge every single
person their reservation price

The monopolist sets a price and quantity such that the total surplus is maximised
Second degree price discrimination:

Different prices are offered based on the quality or quantity demanded

Can be used to determine different types of consumers
Example Plane tickets

Third degree price discrimination:

The monopolist does not know the consumers reservation price BUT they
use a certain attribute to put them into a certain group
The group that is created usually has a trend in reservation prices