Decision making in Markets
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Markets are made up of buyers (demand) and sellers (suppliers)
Consumer demand
Marginal principle
Decisions about quantities are best made incrementally.
Marginal benefit when benefit > opp cost (next best thing)
Marginal cost is the cost added. // when opp cost/price$ > benefit
Market demand
Market demand is just the sum of individual demand
Interdependence principle
it is important to recognise that your best choice depends on your other choices, the choices
others make, developments in other markets, and expectations about the future.
Elastic demand
When the quantity is affected by price is large
When there are lots of substitutes (buyer can compromise if $ is too high).
Flat demand curve
Inelastic demands
When the quantity is affected by price is small
When there are no substitutes (buyer is forced to accept change is price)
Steep demand curve
Elastic=
Take the absolute value of the Quantity (as when ↑Price, Quantity↓ thus negative).
Factors that change consumer demand.
Income
If Incomes ↑, normally quantity would ↑ too. However, if it is an inferior good quantity
would ↓, because people want better alternatives (Coles baked beans vs Heinz) and Vice
Versa.
Preferences
Prices of related goods
If price of a good with a substitute ↑, then demand for substitute good would ↑.
If price of a good with a compliment ↑, then demand for the OG good would ↓, (people don’t
want the original good anymore if it cant be with the complement good.)
Expectations
Congestion and network effects
The type and number of buyers. . . but not a change in price. (This is a movement along the
demand curve.)
Firm supply: Market structure and market power
Market power
Ability to raise your price without losing demand.
Imperfect competition
A market that doesn’t meet the conditions of a perfectly competitive scenario. i.e. in between
perfect competition (a bunch of competitors so no market power) and monopoly (no
competitors, and a lot of market power)
Oligopoly
A market with a few large sellers
Monopolistic competition
A market with many small businesses competing, each selling differentiated products
Have some market power due to differentiating, but limited due to ↑ competition
Graphic Summary:
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Firm supply: Perfectly competitive markets
Firms will sell a product if the marginal benefit > marginal costs
Reservation price
minimum amount the seller would sell for.
Marginal benefit is the price the firm receives, and the marginal costs which is COGS
Diminishing marginal product
As businesses use more inputs, the output might grow at a faster rate initially, then steady,
but ultimately, it will grow at a declining rate.
i.e. If it costs me $1 to produce each slice banana bread, but takes me an increasing amount of
time to make it (i get tired), my output decreases.
Market supply in competitive markets
Total market supply = all individuals firm supply added.
Elastic supply
When quantity changes to price changes (high)
Flat curve
Inelastic supply
When quantity changes to price changes (low)
Steep curve
Short-run analysis
There is a fixed set of competitors in the market
Only need to consider the marginal cost of increasing production (depends on variable costs
[labour, raw materials]) which change with quantity of output
But when businesses want to exit, they have to consider fixed costs, which do not change
with quantity of output (such as rent)
Fixed costs do not affect marginal costs (as they aren’t added costs - they don’t change as
you produce more output)
Long-run analysis
There is free entry and exit in the market.
Firms will enter the market if the market price is greater than their average cost.
Firms will exit the market if the market price is less than their average cost.
Factors that shift market supply
Input prices
If ↑input prices, quantity ↓
Productivity and technology
If productivity and tech. ↑, quantity ↑
Prices of related outputs
Expectations
The type and number of sellers
. . . but not a change in price. (This is a movement along the supply curve.)
A firm may choose to exit when p x q (revenue) < total costs (incl. opp cost)
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AC will be high at first as immediate lump-sum payments
It will go down as the business expands
Eventually as Marginal costs increase, AC will follow.
Profits as displayed
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Competitive market equilibrium
Excess demand
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Upward pressure on prices
Excess supply
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Downward pressure on prices
Equilibrium price is where quantity demanded = quantity supplied (no excess S&D).
Prices are determined by
S&D
the margin (Water&Diamond paradox)
Consumed by someone with an abundance thus not scarce, rather than someone with none of
it and is infinitely valuable.
View for consumers:
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View for firms
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Entry and exit view (firms)
Exit
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Entry
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No one wants to Entry or Exit
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This means firms make 0 economic profit
But economic profit ≠ accounting profit
This is because economic profit includes the opportunity cost of selling equip, salaries, time
etc. So really, there is an accounting profit. (HOW COOL)
Firm supply: monopoly
When a firm chooses a price, they also choose the quantity (although the market has
to be willing - u can’t sell a phone for $1M)
Cost side is the same
Revenue is different...
For a perfectly competitive firm, MR = p
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