Readings
Readings
Baye 6th edition or 7th edition, Chapter 2
BA 445 Lesson A.2 Competitive Equilibrium
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Overview
Overview
BA 445 Lesson A.2 Competitive Equilibrium
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Overview
Substitutes and Complements describe goods that either clash or match. — So,
they explain the affect of higher-priced Coke on the demand for Pepsi, but not
higher-priced housing on the demand for cars.
Comparative Statics determines how competitive equilibrium price and quantity
react to a change in a determinant of demand or supply. — So, how is customer
service affected by increasing US wages?
Price Restrictions impose either maximum or minimum legal prices. Unintended
consequences include shortages and surpluses, and contrary full economic
prices when demanders or suppliers compete.
BA 445 Lesson A.2 Competitive Equilibrium
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Substitutes and Complements
Substitutes and Complements
BA 445 Lesson A.2 Competitive Equilibrium
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Substitutes and Complements
Overview
Substitutes and Complements describe goods that either
clash or match. — So, they explain the affect of higherpriced Coke on the demand for Pepsi, but not higher-priced
housing on the demand for cars.
BA 445 Lesson A.2 Competitive Equilibrium
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Substitutes and Complements
Simplified Definition
• A common definition is Good X and Good Y are
•
•
substitutes if an increase in price of X increases demand for Y
complements if an increase in price of X decreases demand for Y
• There are examples when that definition makes sense:
•
Apples and oranges: An increase in price of apples increases demand
for oranges because consumers substitute one fruit for the expensive
fruit.
• But in some other examples that definition makes no sense:
•
•
Pepperdine and oranges: An increase in tuition at Pepperdine
decreases demand for oranges but not because Pepperdine and
oranges are complements. (Rather, consumers can no longer afford
fruit.)
Pepperdine and Raman noodles: An increase in tuition at Pepperdine
increases demand for noodles but not because Pepperdine and
noodles are substitutes. (Rather, consumers can no longer afford other
food.)
BA 445 Lesson A.2 Competitive Equilibrium
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Substitutes and Complements
• A later lesson extends the definition of substitutes and
complements to gross substitutes and gross
complements.
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Comparative Statics
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Overview
Comparative Statics determines how competitive
equilibrium price and quantity react to a change in a
determinant of demand or supply. — So, how is customer
service affected by increasing US wages?
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Comparative Statics Question
• How do the equilibrium price and quantity change when
a determinant of supply and/or demand changes?
Example: The Wall Street Journal reports that the prices of
PC components are expected to fall by 2 to 4 percent
over the next six months.
• Scenario 1: You manage a small firm that makes PCs.
• Scenario 2: You manage a small software company.
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Scenario 1: Implications for a Small PC Maker
• Step 1: Identify which goods are affected.
• Step 2: Draw and analyze Demand and Supply graphs.
• Step 3: Organize an action plan (worry about details).
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Big Picture: Impact of decline in component (normal input)
prices on PC market
S
Price
of
S*
PCs
P0
P*
D
Q0
Q*
Quantity of PCs
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Analysis
• Equilibrium price of PCs will fall, and equilibrium quantity
of PCs will increase.
Action plan (plan ahead because actions take time)
• Input suppliers? Tell them you’ll increase your orders (for normal
inputs).
• Human resources? Start a job search and training now for
employment to start after component prices fall, assuming labor is a
normal input.
• Marketing? Plan marketing for increased sales after component
prices fall.
• Get quantitative estimates of the qualitative effects above (not
covered in this chapter).
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Scenario 2: Implications for a Software Maker
• More complicated chain of demand and supply graphs.
• Step 1: Use Scenario 1 analysis to deduce that lower
component prices will lead to


a lower equilibrium price for personal computers.
a greater number of personal computers sold.
• Step 2: How will those changes affect the demand and
supply graph in the software market?
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Big Picture: Impact of lower PC prices on the software
(gross complement) market
S
Price
of Software
P1
P0
D*
D
Q0 Q1
Quantity of Software
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Analysis
• Equilibrium price of software will increase, and
equilibrium quantity of software sold will increase.
Action plan (like the plan for PC makers)
• Input suppliers? Order more distribution disks.
• Human resources? Start a job search and training now
for employment of distribution people to start after
demand increases.
• Marketing? Plan marketing for increased sales.
• Get quantitative estimates of the qualitative effects
above (not covered in this chapter).
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Price Restrictions
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Overview
Price Restrictions impose either maximum or minimum
legal prices. Unintended consequences include shortages
and surpluses, and contrary full economic prices when
demanders or suppliers compete.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Price Restrictions
• Price Ceilings
 Set a maximum legal price that can be charged.
 Some examples
• Affordable health care.
• Housing in New York City.
• Gasoline just after OPEC.
• Price Floors
 Set a minimum legal price that can be charged.
 Some examples
• Minimum wage.
• Agricultural price support.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Effect of a price ceiling on health care is an immediate
shortage since demand increases and supply decreases.
In the graph, as price
decreases from the
equilibrium P to the
maximum Pm,
 Demand increases
from Q to B
 Supply decreases
from Q to A
 The smaller quantity
(A) will be
exchanged.
 B-A is a shortage.
Price
Qs
P
Pm
Qd
Quantity
A
Q
BA 445 Lesson A.2 Competitive Equilibrium
B
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Price Restrictions
Competition among demanders to be the ones to buy
some of the limited supply eliminates that shortage by
adding a non-pecuniary (non-money) price that demanders
pay.
In the graph, to buy the
good, demanders pay
price pm plus a nonpecuniary price (like the
cost of waiting in line),
making the total price Pf,
 At Pf, demand is
reduced to A
 Demanders pay Pf
 Suppliers receive Pm
 Pf - Pm is the nonpecuniary price.
Price
Qs
Pf
P
Pm
Qd
Quantity
A
Q
BA 445 Lesson A.2 Competitive Equilibrium
B
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Price Restrictions
Full Economic Price is the dollar amount paid to a
supplier under a price ceiling plus the non-pecuniary (nonmoney) price demanders pay through their competition to
buy.

Ironically, the full
economic price Pf is
greater than the price
P if there were no
price ceiling.
Price
Qs
Pf
P
Pm
Qd
Quantity
A
Q
BA 445 Lesson A.2 Competitive Equilibrium
B
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Price Restrictions
Nonpecuniary cost of health care
Canada has a price ceiling on health care
• The nonpecuiary cost is patients waiting:



Wait times are nearly a year for knee replacement surgery.
Six months for hip replacements.
Three months for brain, prostate and breast cancer surgeries.
• One prediction not covered in the supply-and-demand
analysis is that some patients die while waiting for
surgery.
• Another prediction not covered is the quality of care is
lower.

Canadians do not get many advanced medical treatments and
use of technologies that are common to Americans.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Nonpecuniary cost of New York City Apartments
New York City has price ceilings on some apartments
• The nonpecuiary cost is waiting or paying an agent

Apartment seekers in NYC often require the services of a real
estate agent or apartment broker to assist them in securing an
apartment lease. Typical broker fees are one month's rent.
• One prediction not covered in the supply-and-demand
analysis is the quality of apartments is lower.

Rent controlled apartments receive lower maintenance and
repair.
• Our supply-and-demand analysis considers only
unsupported price controls, meaning the government
does not increase supply.

Housing price support includes building low-cost housing.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Nonpecuniary cost of Gasoline just after OPEC
The U.S. had a price ceiling on gasoline in 1973 after
OPEC reduced the supply of oil to increase price.
• The non-pecuiary cost is waiting at the station. The cost
includes both time and burning gas in line.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Effect of a price floor on wages is an immediate surplus
(unemployment) since demand decreases and supply
increases.
In the graph, as price
(wage) increases from
the equilibrium P to the
minimum Pm,
 Demand decreases
from Q to A
 Supply increases
from Q to B
 The smaller quantity
(A) will be
exchanged.
 B-A is a surplus
(unemployment).
Price
Qs
Pm
P
Qd
Quantity
A
Q
BA 445 Lesson A.2 Competitive Equilibrium
B
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Price Restrictions
Part of that demand decrease is outsourcing jobs to
cheaper foreign labor, and part is replacing humans with
machines.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Competition among suppliers (workers) to be the
ones to sell to meet some of the limited demand eliminates
that surplus by subtracting a non-pecuniary (non-money)
price from what suppliers receive.
In the graph, to sell the
good, sellers receive
price pm minus a nonpecuniary price (like the
cost of waiting in line),
making the total price Pf,
 At Pf, supply is
reduced to A
 Demanders pay Pm
 Suppliers receive Pf
 Pm - Pf is the nonpecuniary price.
Price
Qs
Pm
P
Qd
Pf
Quantity
A
Q
BA 445 Lesson A.2 Competitive Equilibrium
B
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Price Restrictions
Full Economic Price is the dollar amount paid by a
demander under a price floor minus the non-pecuniary
(non-money) price suppliers pay through their competition
to sell.

Ironically, the full
economic price Pf is
lower than the price
P if there were no
price floor.
Price
Qs
Pm
P
Qd
Pf
Quantity
A
Q
BA 445 Lesson A.2 Competitive Equilibrium
B
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Price Restrictions
Nonpecuniary cost of minimum wages
The U.S. has a federal minimum wage and some states
(intending to be sensitive to the poor) have higher minimum
wages.
 The non-pecuniary cost to getting a minimum wage job
includes



Dressing well, being agreeable or attractive to your boss, being
bilingual, being on honors student.
Showing up early and staying late, off the clock.
Working at a faster rate.
• One prediction not covered in the supply-and-demand
analysis is the environment of the job is lower.


More unsafe.
Less comfortable.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Example: Fast-food workers protest for higher wages in
Los Angeles
http://faculty.pepperdine.edu/jburke2/ba445/PowerP1/MiniWage.pdf
The article above describes fast-food protests that started
in New York spread to Los Angeles and other cities across
the nation Thursday as workers called for higher wages
and the chance to unionize. In one case, dozens of fastfood workers and supporters marched outside a South Los
Angeles Burger King at 6 a.m., chanting their demand for a
$15-an-hour minimum wage.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Analysis
“One worker who planned to protest told KTLA-TV early
Thursday morning that it’s unfair that some of his
colleagues have been in the industry for more than 20
years and they still earn 8 bucks an hour. They have a
family to feed and everything….They have two, three jobs
and things just shouldn’t be like that, he said.”
1. Having a family (spouse, children) is a choice an
individual makes to make himself better off. It does not
make one more needy.
2. No matter how needy are workers, increasing minimum
wages hurts them (makes them more needy) because
of competition for jobs.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Analysis
“Industry groups such as the International Franchise
Association said protesters' goals are unrealistic. Individual
franchisees, not the bigwigs at corporate headquarters,
determine wage levels for workers, according to the group.
And many such operators are contending with thin margins
made worse by a lagging economy, high commodity costs
and soaring energy costs, according to the group.”
1. A lagging economy should increase (not decrease)
demand for fast food, since it is an inferior good, and so
increase demand (and wages) for fast-food workers.
2. Higher input costs decrease the supply of fast food,
which in turn decreases demand for fast-food workers.
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Analysis
“Mandating increased wages would lead to higher prices
for consumers, lower foot traffic and sales for franchise
owners, and ultimately, lost jobs and opportunities for
employees to become managers or franchise owners, …”
1. Mandating increased wages decreases the supply of
fast food, which leads to higher prices for consumers
and lower sales.
2. Mandating increased wages leads to lost jobs.
BA 445 Lesson A.2 Competitive Equilibrium
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Review Questions
Review Questions
 You should try to answer some of the review
questions (see the online syllabus) before the next
class.
 You will not turn in your answers, but students may
request to discuss their answers to begin the next class.
 Your upcoming Exam 1 and cumulative Final Exam
will contain some similar questions, so you should
eventually consider every review question before taking
your exams.
BA 445 Lesson A.2 Competitive Equilibrium
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BA 445
Managerial Economics
End of Lesson A.2
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