Market Outcomes
Executive MBA 512
Session #11
Presented by
Brian Greber
November 15, 2012
5-1
Cleaning Up Supply from Last
Class
5-29
Market vs Individual Supply?
• In contrast to individual consumers, it is often important to
understand the economic supplies of individual firms:
• Your firm
• Concentrated Industries
• From a price and market perspective the focus becomes
“market supply”
• the collective supply of all firms.
• We infer this from historic price/production behavior
5-29
What causes supply to shift?
• Number of sellers
• Anything that shifts marginal costs:
• Resource prices
• Technology
• Taxes and subsidies
• Prices of other goods (opportunity costs)
• Producer expectations
5-4
Shape/slope of supply
• Note, the shape is measuring the responsiveness of cost to
changes in quantity supplied
• Inversely, the shape reflects the responsiveness of quantity
supplied to changes in price
• What economists call “price elasticity” of demand
EsX=
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
5-5
Price Elasticity of Supply
Extreme cases
Examples?
• Perfectly inelastic supply
• Perfectly elastic supply
• Unitary Elasticity
p
S
p
p
S
Q
Q
S
Q
5-6
What influences slope of supply
• Shape of curve for inputs
• Diminishing returns
• Time
• Market period
• Perfectly inelastic supply
• Short run
• Fixed plant size
• Long run
• Adjustable plant size
• Supply more elastic
• More elastic in the long run
5-7
January 2012 Article on End of
Elastic Oil
• How did they characterize the overall elasticity of supply for
oil?
• How did they say it differed between the OPEC countries
and the US? Why
• Is the elasticity of oil greater in the long run or the short
run? Why?
• Did the article contend that the short-run elasticty of
supply is getting “more or less” elastic through time?
Why?
• Dies this contradict the preceding point?
• Diminishing returns
• Time
5-8
• Market period
Cross Price elasticity of supply
• Elasticity > 0, production complements ….. Examples?
• Elasticity < 0, production competitors …. Examples?
EsXY=
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product Y
5-9
Law of Diminishing Returns
• Fixed technology
• Add variable resource
to fixed resource
• Marginal product will
decline
• Beyond some point
• The faster the rate
of decline, the
steeper the marginal
cost/supply curve
They Need a Heavier Donkey...
5-10
Law of Diminishing Returns
(1)
Units of the
Variable Resource
(Labor)
0
1
2
3
4
5
6
7
8
(2)
Total Product
(TP)
0
10
25
45
60
70
75
75
70
]
]
]
]
]
]
]
]
(3)
Marginal Product
(MP),
Change in (2)/
Change in (1)
10
15
20
15
10
5
0
-5
Increasing
Marginal
Returns
Diminishing
Marginal
Returns
Negative
Marginal
Returns
(3)
Average
Product
(AP),
(2)/(1)
10.00
12.50
15.00
15.00
14.00
12.50
10.71
8.75
5-11
Total Product, TP
Law of Diminishing Returns
30
20
10
0
Marginal Product, MP
TP
20
1
2
3
Increasing
Marginal
Returns
4
5
6
7
8
9
Negative
Marginal
Returns
Diminishing
Marginal
Returns
10
AP
1
2
3
4
5
6
7
8
MP
9
5-12
Graphical Relationships
Average Product and
Marginal Product
Production Curves
AP
MP
Quantity of Labor
AVC
Cost (Dollars)
MC
Cost Curves
Quantity of Output
5-13
Costs and decisions
• Average fixed cost
• Understand effect of scale on “leveraging” costs
• Average variable cost
• Key controllable cost on a day-to-day basis; key to shut down
economics
• Produce as long as P > AVC
• Average total cost
• Standard for “cost accounting”
• Marginal cost = Supply
• Key to determining profit maximizing output levels
• Competitive firm Produce to where P=MC
5-14
Key take away: Supply
• Supply reflects the marginal cost of production
• Any market or policy changes that influence marginal
costs will shift supply.
5-15
July 2012 Article on Ethanol and
Corn & October Article on Yeast
• If requirements for ethanol use stay the same and the price of gasoline
rises, what is apt to happen to the supply of corn for food purposes ?
What does that say about the cross price elasticity of supply?
• What would happen to food prices related to corn as a feed, grain, or
vegetable?
• If the demand and price of corn for ethanol falls, what would happen to
the demand for yeast?
• What does that say about the cross price elasticity of demand for
yeast?
• So what does that mean that an increase in oil prices will eventually do
to yeast prices?
• Now you are thinking like an economist…….
5-16
Today’s New Objectives
• Review the neo-classical “competitive” market and discuss
exceptions. These will include non-competitive markets, imperfect
information, and externalities.
• Enable a structured approach to thinking through trends, cycles, and
fluctuations in market prices and quantities.
• Provide basic framework for thinking through the “conduct” of
consumers, suppliers, and producers (competitors).
• Place these concepts into a strategic planning framework and
understand their implications for government policy.
5-17
Pure Competition ?
5-18
Assumptions for efficient market
• Private property
• Yields investment, innovation, exchange, maintenance,
& growth.
• Freedom of enterprise and choice
• Scalability, Entry and exit
• Self-interest
• Creates “checks and balances”
• Costs and benefits understood, and internalized
• Information
• Lack of “side effects”
• Fair Competition among players
• Many players on “both sides of the market”
• No lying, cheating, stealing, colluding, ….
• Markets and prices allowed to function ans supported with viable currency
5-19
Market Equilibrium …..
•
•
•
•
The meeting of the minds that balances price and quantity
Avoids surplus and shortage
Uses price for Rationing
Leads to Efficient allocation
• Productive efficiency
• Allocative efficiency among consumers and producers
5-20
Putting D&S together
5-21
Competitive Equilibrium is Good!
Price (Per Bag)
Consumer
Surplus
Equilibrium
Price = $8
P1
D
Q1
Quantity (Bags)
5-22
5-22
Competitive Equilibrium is Good!
Price (Per Bag)
S
Producer
Surplus
Equilibrium
Price = $8
P1
Q1
Quantity (Bags)
5-23
Competitive Equilibrium is Good!
S
Price (Per Bag)
Consumer
Surplus
Equilibrium
Price = $8
P1
Producer
Surplus
D
Q1
Quantity (Bags)
5-24
Putting D&S together
What happens if
you instill quotas,
price ceilings, or
floors?
5-25
Truth is ….. The market is rarely at a
competitive equilibrium!
5-29
Market Cycles:
Imperfect Information Causes “Oscillations” in
Prices, Outputs, and Inventories
• How do I know what price to
charge?
• What happens if I charge too much?
• What happens if I charge too little?
• What actually happens in the market
is sometimes called “the cobweb
effect”
5-27
Market Cycles:
Imperfect Information Causes “Oscillations” in
Prices, Outputs, and Inventories
Price/
Production Q
New York Times Article on Inventories
Inventory
Time
5-28
Market Trends:
Inertia/Momentum causes supply/demand to
continually shift through time
• Population
• Productivity
• Scarcity (?)
• Other ????
•
5-29
Market Equilibrium: Use Board
Supply shift out; Demand
decrease
Supply shift in; Demand
increase
Supply shift out; Demand
increase
Supply shift in ; Demand
decrease
Price
Quantity
?
?
?
?
5-30
5-30
Market Shocks: One time events,
start the cobweb, again!
Price/
Production Q
Inventory
Time
5-31
Trend and Cycle
Price or
Quant
Trend
Trend
& Cycle
Time
Full disclosure and “internalization”
of all costs/benefits is critical to
efficient markets …..
5-29
Asymmetric Information: Bad thing!
P
P
Hidden costs
St
St
Misrepresented
benefits
S
Dt
D
D
Overallocation
0
Qo
Qe
Q
0
Overerallocation
Qo
Qe
Q
See: Law school debt, Reebok articles
Consider: What happens when consumer lies on insurance forms
Information witheld by buyer or seller is inefficient.
5-34
Externalities
9-35
Inefficient Equilibrium: Externalities
5-36
Inefficient Equilibrium: Externalities
P
P
Negative
Externalities
St
St
Positive
Externalities
S
Dt
D
D
Overallocation
0
Qo
Qe
Negative
Externalities
Q
0
Underallocation
Qe
Qo
Q
Positive
Externalities
5-37
Number of players influences
market outcomes…..
5-29
What limits competition?:
Barriers to Entry
•Economies of scale
•Legal barriers to entry
•Patents
•Licenses
•Ownership or control of essential resources
•Capital intensity
•Pricing and other strategic barriers to entry
5-39
Market Structure (Models)
Market Structure Continuum
& exit
Demand to
firm
Perfecty
elastic –
Price taker
Nearly Perfecty
elastic –
Price taker
Typically
“kinked”
Downward
sloping =
market D
7-40
Monopoly Fundamentals
• Single firm faces entire demand schedule.
• Firm’s output decision drives market rice (conversely price decision drives
market quantity).
• MR curve is below price curve, because price change effects all prior units
of production.
• Monopoly will produce where MR=MC;
• Outcome (assuming no cost advantage):
• Lower Quantity
• Higher Price
• Disproportionate allocation of market value to producer profits
• Inefficiency compounded when monopolist price discriminates
5-41
Monopoly Fundamentals
Pure
Monopoly
Purely
Competitive
Market
S=MC
MC
b
Pm
P=MC=
Minimum
ATC
Pc
c
Pc
a
D
D
MR
Qc
Qm
Qc
Pure competition is efficient
Monopoly is inefficient
7-42
5-42
Monopoly Fundamentals
5-43
Oligopoly & Monopolistic
Competition
5-44
Monopolistic Competition
•
•
•
•
Fairly large number of suppliers
Easy entry and exit
Segmentable markets
Differentiation allows for non-price competition
• Enables firm’s some capability to manage pricing.
• Potentially inefficient, depending upon pricing
control
Which industries?
5-45
Oligopoly
• A few large producers – enabled by entry barriers
• Four-firm concentration ratio
• Needs to be more than 40%
• Half of U.S. manufacturing
• Homogeneous or differentiated products
• Collusion is mutually beneficial
• Enhances profit
• Incentive to cheat
• Sans collusion – the “kinked demand curve”
• Raise price, others don’t follow, big loss in share
• Lower price, others follow to preserve share
5-46
Oligopoly: Kinked Demand
Can be complicated – simple version …
Price and Costs
Rivals Ignore
Price Increase
D2
P0
e
Rivals Match
Price Decrease
D1
0
Q0
Quantity
MR1
7-47
5-47
Oligopoly: Price Outcomes
•
•
Price
Wait for the “first to move” then follow
Less frequent price changes than competitive markets
Competitive
Market
Oligopoly Market
Price
Time
Time
5-48
Pricing Examples
Pulp – a relatively
concentrated industry
Lumber – a highly
competitive industry
Oligopoly: Issues/Options
•
•
•
•
•
Not productively efficient
Not allocatively efficient
Tendency to share the monopoly profit
Considerations
• Increased foreign competition
• Technological advance
Policies
• Use antitrust laws
• Divide the firm
• Natural monopoly
• Regulate price
• Ignore
• Unstable in long run
Factors influencing
degree of competition
in your industry
Shape of industry
supply curve and
other cost
considerations
Dynamics of the
“shoot-out”
Shape of industry
demand curve and
other demand factors
5-51
Special Topics from the Anti-Text
• Shapes of the cost curves
• To some extent the argument is irrelevant, one needs to
believe in aggregate there is some form of upwards
sloping supply function. Individual firms need not see
significant price elasticity of supply.
• Switching suppliers (p. 107) – who can you turn to if all
producers are already producing at optimal levels?
• Do we overstate the freedom of choice argument in
markets?
• What does it depend upon?
• Does that invalidate the basic market model? Parts of it?
5-52
Assignment
• Using Excel graphically contrast historic market prices and quantities of 4
assigned commodities and discuss reasons for the trends, cycles, and
fluctuations. Summarize how market structure is apt to influence behavior
and rivalry and show concrete examples. Support your graph with a
reflection paper (no more than 2 pages).
• Due 12/3
• Instead of 4 assigned, use any 2 good(s) you wish; ideally one is the
same as that used in assignment for session #5.
• Find monthly data for at least 7 years.
• 2 graphs – one of prices, one of quantities. Each should have 2 lines on
them (one for each of 2 goods)
• I am looking for “likely” reasons for trends, cycles, and “shocks”; not a
statistical analysis.
• I am looking for examples of behavior and rivalry that might drive the
observed prices and quantities.
5-53