2.964: Economics of Marine Transportation Industries
Prof. Hauke Kite-Powell
Lecture Notes: Market Economics
Market
Buyers & sellers interact
Profits/losses guide firms’ decision on what/how/for whom
demand
supply
GOODS
MARKET
PRICES
cost of production
(pricing)
buying
decisions
CONSUMERS
(households)
PRODUCERS
(firms)
input
ownership
payrolls, rents
supply
FACTOR
MARKET
PRICES
demand
labor (wage)
land (rent)
capital (interest rate)
TWO POINTS:
*
Ceteris paribus – “other things equal”
Movement along supply, demand curves vs. shift in curves
“Increase in demand” Æ shift (non-P Δ)
“Increase in q demanded” Æ movement?
*
Idealization – perfect competition
- individual actions have no appreciable affect
- shipping?
- P = MC – efficient (no “excess” profits)
Failures (Role of Government):
- imperfect competition (monopoly)
- externalities Æ cost imposed outside markets, involuntary
Tanker Market Examples
Demand Curve
P
Shifts:
- Δ in factors
other than price
Downward sloping – why?
- substitution effect
- income effect
Determinants:
- price
- income
- size of market
- substitutes (related goods)
- tastes / preferences
D
Q
Supply Curve
Upward sloping – why
- law of diminishing
returns
P
S
Shifts:
- Δ in non-price
factor(s)
Determinants:
- price
- cost of production
o technology costs
o input costs
- prices of production
substitutes
Q
- market org.
Equilibrium
Supply Shift
P
P
S
Demand Shift
P
S
S’
D
Q
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
S
D’
D
Q
D
Q
Prof. Hauke Kite-Powell
Page 2 of 9
ELASTICITY
Price elasticity of demand: E D =
% incr. in Q
, NOT = slope!
% incr. in P
Elastic
Inelastic
P
perfectly
inelastic
perfectly
elastic
Q
Revenue = P x Q
- decreases when P increases
Q
Revenue = P x Q
- increases when P increases
Examples:
- Luxury goods
- Ready substitutes
- Large fraction of income
Price elasticity of supply: E S =
P
-
Necessities
No ready substitutes
Small fraction of budget
% inc. in Q supplied
% increase in P
ES = 0
ES = 1
Determinants:
- time period
- extent to which production
can be increased
ES = ∞
Q
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
Prof. Hauke Kite-Powell
Page 3 of 9
Time Frame of Equilibrium
- monetary (supply fixed)
- short run (plant & equipment fixed; output Δ)
- long run (everything can Δ)
Smom
Sshort
Slong
ΔPm
ΔPL
ΔPS
D’
D’
D’
D
D
D
ΔPm > ΔPS > ΔPL
Similarly for demand, elasticity is smaller in short run
Very short run: prices move violently, Q little
Very long run: P moves little, Q a lot
Effect of a Tax
P
S’
$1.00
18.9
$1.00/barrel of oil imports
Who bears the burden?
S
Oil co: .9 – 1 = -.1
Consumer: .9
18
D
Q
100mb
*
Elasticity!
Burden on consumer if demand inelastic
relative to supply.
Burden on producer if supply is inelastic.
Effect of Price Control
P
Æ shortage
S
E w/o ceiling
Examples:
price ceiling
D’
rent control
interest rate ceilings
minimum wage
D
Q
shortfall
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
Prof. Hauke Kite-Powell
Page 4 of 9
UTILITY (Behind the Demand Curve) = Satisfaction
total
utility
diminishing
marginal
utility
marginal
utility
Q
Q
Consumers adjust consumption so that marginal utility per $ is same for all goods.
MU
same for all goods
P
Æ “explains” downward sloping demand curve (higher P Æ MU
P
Æ MU determines value, i.e. price
Æ reduce Q)
MARKET DEMAND
= sum of individual demand curves
A
B
+
total
=
SUBSTITUTES + COMPLEMENTS (independent)
Substitutes: increase in price of A causes increase in demand for B
Complements: increase in price of A causes decrease in demand for B
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
Prof. Hauke Kite-Powell
Page 5 of 9
CONSUMER SURPLUS
P
= extra utility (value) consumers collectively
receive
S
D
Q
PRODUCTION FUNCTION (Behind the Supply Curve)
= relationship between inputs & max output
marginal
product
total
product
input
diminishing
returns
input
Returns to Scale: balanced increase and decrease of all factors at once
Constant
Decreasing
Increasing
Productivity =
(replication)
(natural resource industries) ?
tanker!
total output
weighted avg. of inputs
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
Prof. Hauke Kite-Powell
Page 6 of 9
COSTS
total = fixed + variable
total (Q) = fixed + variable (Q)
TC = FC + VC
= 0 when
Q=0
(sunk)
no ∆ with Q
Marginal Cost = MC = additional cost of producing 1 more unit of output
= slope of TC curve
Average Cost = unit cost =
TC
q
MC = supply
curve
TC
AC
Cost
$
FC
q
q
Relating Marginal Product and Marginal Cost:
MC
MC
dim.
returns
MP
input
Like consumers with MU , firms adjust inputs so that MProduct is same for all
P
P
inputs
Opportunity cost: measure of what has been forgone
Industry supply = horizontal sum of firms’ supply
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
Prof. Hauke Kite-Powell
Page 7 of 9
COMPETITIVE MARKET
Assume:
P
- competitive firms/market (no producer can affect market price)
- firms maximize profits
industry
P
firm
D
D
Q
Q
industry
firm
How does firm decide how much to produce?
Æ P = MC
P
Why?...
MC
D
rising MC curve =
firm’s supply curve
firm
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
Q
Prof. Hauke Kite-Powell
Page 8 of 9
P
Shutdown Point
supply curve
breakeven
(short run)
MC
AC
AVC = avg. variable cost
d
shutdown
Firm Q
Æ profit maxing firms may continue to operate in the short run even though they are
losing money
Industry Supply = horizontal sum of firm’s supply curves
Long-run competitive equilibrium: P = MC = min AC = breakeven price
SURPLUS
P
consumer
surplus
S
equilibrium
producer
surplus
2.964: Economics of Marine Transportation Industries
Lecture Notes: Market Economics
D
Q
Prof. Hauke Kite-Powell
Page 9 of 9