Comments please
Rachel Gordon
Econ 201
Ashby
Chapter 7, 8, and 9
Chapter 7
Consumer sovereignty is when market actions reflect solely on what the consumer
wants. If the consumer wants more, the market will produce more. Figure 7-1 displays
the market demand curve. To construct a market demand curve, you must choose a price
level on the vertical axis. The horizontal axis displays quantity, the amount demanded by
consumers. At each price on the vertical axis there is a demand, by plotting several of
these points and connecting them, you will be able to construct a market demand curve.
Let’s examine a situation: if a firm has achieved long-term equilibrium, then the
price of their product or service is not likely to change. How would this firm change if
they had a substantial increase in demand? In figure 7-4, the demand curve has shifted to
display the increase in demand. The first step in the six-step response process is the
increase in demand, displayed in figure 7-4. The second step is increasing the price of the
product or service to balance supply and demand. While trying to find the balance,
suppliers must supply more. In response, buyers will cut demand. When Suppliers
increase supply, they will also increase the price of the product. Suppliers do this to
maximize profits. To maximize profits, firms should run according to MC curve.
Suppliers have to increase price when increasing output or their profits will decrease a
noticeable amount. Step three in the response process is to block entry of competitors. If
firms succeed in this step, the response process will stop at step three. If a Firm’s total
average revenues increase and are steady, the firm will look attractive, which often
attracts competitors. If competitors are attracted, entry of competitors is step four and the
response process continues. Step five is the increase in supply. When there is an increase
in supply, suppliers’ prices will decline in order to increase demand. Total revenues will
also start to decrease, but until it decreases to zero profits, new suppliers will keep
entering the market. Step six is when the entry of new suppliers comes to a halt and the
industry is back to long-run equilibrium.
Figure 7-7 displays the constant cost industry. The constant cost industry is when
the firms do not move or change prices. In figure 7-8, increasing cost is displayed by the
cost curve rising. Industries do this to make sure a profit is made. Figure 7-9 displays
decreasing cost industry. In this example, industries are able to cut costs in producing the
product, resulting in profits. In each scenario, the entry of competition is the important
factor. Without competition there would be a lower output with a high price. Competition
lowers prices, but still receives some economic profit.
On the other side of the spectrum, the initial rise in price and revenues is crucial
because that attracts competition. Now we need to evaluate what happens when demand
drops. When there is a decrease in demand, firms start dropping out of the industry,
resulting in a shortage of supply. To restore a shortage of supply in relationship to
demand, traders raise their prices. As a result, firms are able to increase outputs and still
stay within the marginal cost curve. Negative economic profits will then start to shrink.
Once negative profits are at zero, people entering or exiting will stop and the industry
will be at long-term equilibrium.
Cost increase can throw off equilibrium. A cost increase can happen for many
reasons, a few are: increase in energy cost, increase in wages, or the US dollar has
dropped in value. As a result of the increased cost, an increase in price will occur.
Though the price increases, it usually does not allow for any economic profit. Firms start
to exit the market do to zero economic profits. Due to firms exiting, a shortage of supply
occurs and prices are able to rise even more. Prices keep rising, as well as output. Now
the cycle has completed.
Cost decrease can also occur. Some examples where cost would decrease is if
there are technological advancements or a more efficient production. The patterns of
supply and demand take place just like it did in previous scenarios. Demand rises, the
prices decrease. Output increases to provide for higher demand. Costs become lower,
resulting in lower prices for the buyer. This satisfies the buyer and the supplier. The
supplier is still gaining positive economic profits while the buyer is able to get the
product at a lower price.
Chapter 8
Most products are differentiated, which means they are not commodities.
Differentiated products mean the products are not the same. The supplier individualizes
the product with unique characteristics and usually has a variety of the same product.
This allows suppliers to be, and operate in a personal market.
Being the sole supplier has some benefits. Sole suppliers can influence the price
of their product because they have an individual market, serving their clientele. The
supplier can choose two ways to run their business: pick a price or a desired volume.
Choosing the latter of the two has a higher chance to maximize profits.
Abiding by scarcity rules, if the firm did not produce as much, the scarcity of the
product would be great and push the price up. On the other hand, if a supplier produced
more the price would be pushed down. If production is high and there are many firms, the
firms’ demand slope will not be steep. If few firms are producing the same product then
the demand curve will be steeper.
In order to have jobs throughout the nation, there has to be jobs available. Jobs are
made available when producers enter the market. On the other hand, jobs are lost when
producers leave the market. When large producers are going to shut down, government
will sometimes step in to help the public’s long-term interests. The government tries to
prevent suppliers from exiting the market by offering worker retraining or short-term
financial support. Though the government is supporting this individual firm, they have to
be cautious and allow room for other firms to enter.
There are three kinds of product efficiency. The first is to choose a rate of output
at a low cost. The second is to produce the lowest average cost per unit; this implies a
firm is running at the bottom of the ATC curve. The third is to produce in the most
efficient production facility. In order to maximize profits, a firm does not require the last
two production efficiencies. If a firm is able to produce the product at the first product
efficiency, they could maximize total profits. This is not always positive for the nation’s
scarce inputs because to gain the maximum product efficiency, all three would need to be
used. Since the firm would still be running at maximum profits, entry of other firms
would begin. This would result in pushing the first firm to run at all three product
efficiencies to reach maximum profits. This would optimize the use of the nation’s scarce
inputs. This scenario is only possible in commodity markets.
Though highly unlikely, it is possible for non-commodity markets to run on all
three product efficiencies. Figure 8-3 displays the highly uncommon circumstances that
would have to take place. The scenario shown in figure 8-3 would not last long because
running a firm at max efficiency attracts competition, changing the firm’s demand. This
is displayed in figure 8-4. The change in demand would result in the firm operating with
the first efficiency again. Though non-commodity markets seem to run less efficient, they
have other positive attributes. Non-commodity markets are able to target one’s taste by
producing a variety of unique products, which enhances a person’s standard of living.
Allocative efficiency can occur when P=MC. If this is the case, non-commodity
markets are unable to reach peak allocative efficiency because they will not be able to
apply socially-optimal amounts of their product.
Suppliers and buyers both have separate goals in the sense that buyers want value
and suppliers want profits. Suppliers work with buyers to get prices low enough so
buyers want to buy, but high enough that the suppliers will still profit. Suppliers have a
little more power in a non-commodity market. If the supplier is able to have a higher
price of a product that buyers are willing to pay, there would be no reason for the supplier
to supply more. If the supplier did supply more, the price would then be lowered to sell
the abundance of supply. The supplier would not be making greater profits, but the same
or less, due to the lower price and greater quantity of supply.
When demand changes, each firm takes on the responsibility to increase supply.
The supply is still not great enough, so the price is raised. These factors attract
competition. Now the competitors will take on some of the current responsibility to
supply. The quantity of supply rises. In response to the raise in supply, the price will
drop. Due to entry still taking place, economic profits start to decrease, and until profits
become negative, entry will not stop. This scenario describes how commodities respond
to the demands of the buyers. In non-commodity markets the supplier does not have to
increase supply.
When costs increase, each supplier will lower their output to compensate for
rising cost of production. Due to the lower production at a higher cost, the price will rise.
The consumer demand will not allow for a rise in price, to compensate for the rise in cost,
as a result negative profits occur. When firms exit, existing firms take on higher quantity
of supply. When firms increase quantity, they will need to increase the price. Firms will
continue to exit until profits reach zero again. The cost increase for commodities is the
same pattern we observed in non-commodity markets.
A cost decrease has the same pattern in a commodity market as that of a noncommodity market. As demand rises, the prices decrease. Output increases to provide for
higher demand. Costs become lower, resulting in lower prices for the buyer. This satisfies
the buyer and the supplier. The supplier is still gaining positive economic profits while
the buyer is able to get the product at a lower price.
Chapter 9
The best way for a firm to achieve profit maximization is when the firm controls
the output during the period of time that would give them the most efficient cost to
revenue number. The firm would also need to charge the highest price possible that
would still allow them to sell all of the output. Instead, often the output is determined by
the supplier and the price will be determined by the demand. A lot of companies work
backwards by selecting the prices and letting the demand decide how much production
there will be. This method is usually known as markup pricing (cost plus pricing).
Problems arise when prices are set too high and output stalls, when the price is too low it
is impossible to maximize profitability. There is no right or wrong price to set as the
markup, but you must be willing to change quickly to maximize profitability.
Price differentiation is the process of selling the same exact product to different
buyers, for different prices, with no reason or justification for the differences. Airlines
are a prime example of shifting prices without raising costs. As long as your demand
percent does not drop more than the price percent rises, the firm is fine. For example, if
you own a theater and you raise your prices 10% from $10 to $11 and usually have a
movie showing of 100 customers, after the price change you lose 8 customers. Instead of
making $1000 off 100 customers, you will make $1012 off of 92. The people who choose
not to pay the price have inelastic price elasticity.
A monopoly consists of a market that only has one supplier with no competition.
Just like any other business, or supplier, monopolies try to reach maximum profit for their
business. New products have copyright protections and patents to make sure the ideas
can get off the ground with little competition. Without protection it would be too risky to
invest in jobs or inventions. There are public monopolies to help reduce overhead and
cost for essentials like public services. Most public services would be more expensive if
they ran as a privately owned company.
An idea that contradicts the normal competition of the free market is collusion.
Collusion is when two competitors work together to reduce the cost of the overhead for
both of the businesses. These groups are called cartels and are illegal in the USA, but not
in other parts of the world. One of the largest cartels in the world is OPEC, with
worldwide oil sales. The reason the cartels are illegal in the US is it allows an individual
or a small group of individuals’ ability to sway the market, or cheat the market with no
profits available to the smaller groups.
Any time you have an outside influence affecting a certain market, for instance,
pollution tax, that then gets passed on to the buyer, and affects the market or the poorly
educated working class, resulting in externalities. Not all externalities are considered
negative. When education is available, everyone is affected in a positive way - a more
educated work force. When people are more educated they get higher paying jobs, which
means more tax revenue for the community.
Throughout US history, including times of higher wage costs, the US has had low
labor costs. As time goes on and other countries become more educated and populations
get larger, the US lead has slipped away. Producers have noticed this and moved many
jobs out of the US. This allows China and India to advance economically, putting
themselves on the world market for many years to come.