Samantha Fummerton
Microeconomics 201 12:00
11/28/2011
Paper #3
Comments:
Samantha Fummerton
Chapter 7
Commodity Markets: Consumer Rule
In chapter seven we discuss consumer sovereignty which is the relationship in how the
market responds to the demand of the consumer. If a consumer demands more of the commodity,
the market will respond by increasing the supply to match. If a consumer demands less of a
commodity, the market will respond by decreasing the supply. The supply and demand responses
can be evaluated by a six step process.
Before we discuss the six step processes, we have to be sure we understand how to build
the demand and supply curves. If there is a total of five buyers in the market, we find the market
demand curve by selecting a price along the vertical axis and finding the distance on the
horizontal axis out to the demand curve. These are the individual prices for each buyer. The sum
of those five quantities, along with other quantities found following the same procedure, make up
the combined market demand curve. They can be plotted on a graph and connected with a line
that has a negative slope. This graph shows that if the market curve shifts horizontally and to the
right there is an increase in buyers, and if it shifts horizontally to the left there is a reduction in
buyers. Now let’s imagine that there are five suppliers in the market. Following the same
procedure as we did to create the demand curve, we can select a price level vertically and map
horizontally the quantity that needs to be produced. The sum of those five quantities, along with
other quantities found following the same procedure, make up the combined market supply
curve. If we increased the number of suppliers, the curve would move to the right, and if we
decreased the number of suppliers the curve would shift to the left. We are only working with a
small amount of buyers and sellers in this example, so in a real world situation a small increase
or decrease in the amount of buyers or sellers wouldn’t show any effect on the graph. If would
take a large number of buyers or sellers to increase or decrease their involvement in the industry
to move these curves. The point on the graph where the two curves intersect is called long-run
equilibrium which is similar to short-run equilibrium which we have discussed in previous
chapters.
The first step in the process of finding the supply response to a demand increase is when
there is an increase in the demand of a commodity, shown on the graph by a shift horizontally to
the right. The second step is when the commodity traders see that they have to increase the price
to balance the supply with the new demand. In the third step suppliers increase their supply along
their MC curve, because in order to maximize profit the company has to operate where the MC
curve is at the same level as the price. Because there has been an increase in demand, and an
increase in price, this opens up the doors for competition. More businesses will want to take
advantage of the demand, but this will also cause the price of the product to drop. Step four
occurs with the entry of new more suppliers. This will cause the market supply curve to slowly
shift to the right. Step five is when the commodity traders start lowering the price to balance the
new supply with demand. Step six described when new suppliers keep entering the market, and
the price continues to drop. This causes a decrease in economic profits for each company
because they will be moving down the MC curve to stay at maximum profit. If there are no
longer any economic profits, entry of new suppliers stops. The company is again in long-ruin
equilibrium. This is one of three possible outcomes.
The outcome referred to above is known as a constant-cost industry. The cost curve has
not changed, because even though the demand is greater the suppliers have not changed their
prices. In an Increasing-cost industry, the suppliers increase their output, but run into higher cost
to make the product in turn the price of the product doesn’t drop below its original level. In a
decreasing-cost industry, the suppliers have increased their output, and have also come up with
new ways to reduce their cost. This could include new technology and software for the company.
In this case, the price of the product does drop below the original level. In all three of these
aspects, having an increase in suppliers is very important. It lowers the price of the product
which is a benefit to the buyer. However, the buyers will see an initial rise in the price of a
product, but it’s important to remember that it is only temporary.
To find the response to a demand decrease in a product, there are also six steps to follow.
The first step is a drop in demand. Step two; the commodity traders decrease the price of the
product. Step three, the company will decrease the output to minimize loses. In step four, this
will cause companies to suffer from a negative economic profit, and some will exit the industry
causing a product shortage. In step five, the commodity traders raise the price of the product the
balance the supply and demand. Step six; the companies will then be able to increase their
output. This will cause the amount of negative economic profit to shrink. Companies will keep
exiting the industry until the economic profit is back at zero and the price is back to its original
level. Again, the company will be in long-run equilibrium.
To find the response to a cost increase of a product, it takes six steps to follow. If we are
again imagining that there are five businesses. The market supply curve can be drawn by
measuring the horizontal increase of the five individual quantities and adding them together. Step
one is noticing a great rise in the cost of a business to run. Step two starts when a firm then starts
decreasing output. Step three, forces the commodity traders to raise the price of the product to
restore balance. Step four; the business will reduce output in order to operate at the level of the
higher price and minimizing their losses causing businesses to leave the industry. Step five, as
there are still negative economic profits, businesses will still leave the industry reducing the
supply to meet the demand. Step six; the business will start to increase their output to match the
price demand.
To find the response to a cost decrease, we first notice a drop in cost for the businesses to
make a product. There will be an identical drop in the market supply curve as well. At the
original price, companies will increase their output. If the price stays the same, the output would
increase, but as the supply rises, the commodity exchangers are forced to drop the price. Because
of the slope of the curve, the price drops farther than the cost. The firm then increases their
output to maximize their profit. The suppliers and buyers are both happy with this outcome.
Because there is a high economic profit, more companies will then enter the industry until the
market is supplied enough for the price to fall.
Samantha Fummerton
Chapter 8
Non-Commodity Markets
In chapter eight we are going to discuss non-commodity markets. In the real world, most
products are not commodities, which mean there are many variations of the same product. A
commodity is something that you can get from various suppliers that is the exact same product.
In non-commodity markets, each suppliers output has different characteristics that suit peoples
preferences, tastes, and bank accounts. For example, there are all different kinds of shoes,
clothes, perfumes, jewelry etc., which are all distinguishable and can suit the population’s
different needs. This makes for a happy buyer, because it provides them with options. Because of
all the variation, each supplier is going to operate on their own market.
Because each supplier’s product is different, they are going to acquire a specific group of
buyers that will become loyal to their product. Suppliers in non-commodity markets have a much
greater influence on the price of a product, because they are the only ones supplying that specific
product. They have more market power. The company however, is not able to decide the price as
well as the amount of sales. They have the choice of either setting the price they want and letting
the market dictate the amount they need to supply, or setting the amount of product they want to
supply and letting the market decide what the price will be. If suppliers want to maximize their
profit however, they will most likely choose the second route and set the amount of supply.
When a company chooses the second route, they can either raise or lower the amount of
supply they are going to provide the market. By lowering the amount of output, the price of the
product is going to rise. By raising the amount of output, the price of the product is going to
lower. This can be represented on a graph by a negative sloping curve. If there are many
companies supplying similar products, i.e. Nike, Reebok, Adidas, etc., the slope of the curve will
not be as steep. Each company would have less market power and raising prices would only
result in a loss of sales. If there are fewer companies supplying a similar product the curve would
be steeper and the company would have more market power allowing them to raise the price
without losing much profit. On a graph, if the MR curve and the AR curve lie below the LRATC
curve, the company wouldn’t be able to avoid receiving negative economic profits from their
product.
In any market economy, all companies are using the countries limited productive
supplies. The better a company uses those scarce resources, the better the standard of living will
be and the company will make a greater profit because they are still producing a valued product.
This is serving the public’s interest, and their profits reflect this. When a company wastes scarce
resources their product is held at a lower value. It is in the company’s best interest to put those
resources to better use. The role of profits and losses are the same as in a commodity market:
profits encourage more companies to enter the market, and losses encourage more companies to
exit the market. Entry into the market by other companies is what creates jobs, creates more
variety and output, and provides a higher standard of living.
If a company’s AR curve lies above the LRATC the company is going to gain positive
economic profit. If the company is trying to achieve maximum profit, a company would have to
choose a facility and output level that would allow MR to equal MC and ATC to equal LRATC.
There are three different kinds of product efficiency. The first is choosing the level of output that
is at the lowest possible average total cost (ATC=LRATC). The second kind of product
efficiency is operating the facility the company is already in, at its lowest average cost per unit.
The third kind of product efficient is operating in the most efficient facility possible. Profit
maximizing only requires the first kind of product efficiency where as maximum production
requires all three kinds of production efficiency. Although highly unlikely, it is possible for a
company to operate at its peak productive efficiency if their MR curve passes directly through
the lowest point on the LRATC curve. If by some chance this outcome were to happen, it
wouldn’t last very long. There would be more companies entering the market driving down the
demand. This shows us that typically in non-commodity markets companies tend to be
productively inefficient.
For a company to achieve the greatest allocative efficiency P has to equal MC. In noncommodity markets, companies don’t achieve peak allocative efficiency because they are not
providing socially-optimal amounts of a product. Companies are under producing their products
and are misusing the nation’s scarce resources. On a graph this can be seen when P is exceeding
the corresponding MR. When P exceeds MR, buyers feel that they aren’t getting what they
deserve. This reflects that the buyers and suppliers interest are different.
Uniform pricing can be described by the following situation: during a time period, one
product will sell for $10. If two of the same products are sold, they will each sell for $9, and if
three of the same products are sold, they will each sell for $8. The marginal revenue of selling
two products would then increase by $8 from $10 to $18. Then increasing the sales to three units,
the marginal revenue would increase from $18 to $24.
Non-commodity markets have a downward sloping demand curve and therefore do not
have a short-run supply curve. On the graph, at one level of output, the resulting price will
depend on which of the possible demand curves the company faces. When a company reaches
long-run equilibrium the supply is equal to the demand at a given price. As more companies
enter the market, the demand per company goes down and will push the AR curve to a point
where it touches the LRATC curve. The company would then have to adjust their output to
match ATC that matches that point. When the company reaches long-run equilibrium
P=AR=ATC=LRACT. There is no economic profit bringing the entry of new businesses to a
stop, but existing companies are making enough to stay in the market.
In a non-commodity market, if the market starts at long-run equilibrium, the demand for
the products will increase. Each of the companies will share part of the demand increase. If the
companies want to keep MR equal to MC they have to increase their output. The raise in
economic profits will attract new businesses to join the market. As more companies join, the
individual demand per business will go down. This will then cause the companies to cut their
output. The increase in total output will also cause the price to decrease and economic profits
will decrease. When economic profits are back at zero entry will stop.
In a non-commodity market, if the market starts at long-run equilibrium, the cost
structure will rise. There are many costs a company will face such as wage increases, higher
energy cost, or government regulations. If costs go up, suppliers lower their output to minimize
their losses. This then causes the price to rise, but not as much as the suppliers wish. This will
result in negative economic profits and lead some businesses out of the industry until the market
gets back to long-run equilibrium. This again shows that entry and exit in a market is very
important.
Samantha Fummerton
Chapter 9
Special Topics
The first topic we are going to discuss is markup pricing. This is when a company sets
the price of a product, and lets the market decide their amount of sales. Companies take the
marginal cost and multiply it by a number greater that 1 but usually less than 5. The number the
company multiplies the marginal cost by is referred to as the products mark up. If the mark up is
too high, the company will sell less product than if it was lower. In order to achieve maximum
profits, a company has to choose the right mark up rate. If demand increases, the mark up rate
will increase, and if demand decreases, the mark up will decrease.
Price differentiation is when a business sells the same product for different prices even if
the cost is the same. For example, setting a price of a movie differently for people who are of
really young, or old ages is an example of price differentiation. . Offering coupons is also an
example of price differentiation. This is a very important tool in understanding the connection
between price elasticity of demand and its revenue which we have previously discussed.
Companies can only use the technique of price differentiation if they can divide their customer
base into groups that have different price elasticities of demand.
Monopolies are also a big part of economics. A monopoly is present when there is only
one option to buy a product. Most people think monopolies are bad because it allows a company
to raise the prices on the product because there aren’t any substitutions and people are forced to
buy the expensive product. In a monopoly, achieving maximum profit is done in the same
manner as if there were competitors in the market. They still have to select an output level and
then let the demand set the price. Most new products typically start out with only one supplier, or
a monopolist. Successful products will produce economic profits often referred to as monopoly
profits. Economic profits will lead to more companies joining the market and then there will no
longer be a monopoly. A way to block entry into the market is to obtain a copyright or patent for
the new product. This allows a company to keep monopoly profits. Without this protection there
would be less variety in products because companies wouldn’t be forced to be creative and come
up with better alternatives. Public utility monopolies are created by the government to prevent
any economic profits. For example the government will divide up a region to be supplied by
different power companies. They are set to avoid companies setting prices as if there were many
competitors.
Collusion is another important topic of economics. When all suppliers coordinate their
efforts to deal with the market as a group like if it was a single supplier, it is called collusion. A
group of these suppliers is called a cartel. In America cartels are illegal, but that is not tha case
for all countries. Cartels work best when they are dealing with commodities where there arent
many suppliers to a single product. Cartels work when all of the companies have a cost structure
in long-run equilibrium. Before forming a cartel, companies did not have as much pull in
deciding what the price of a product is going to be. If these companies decided to join together,
they would have a lot more power in deciding what the price of a product would be. There would
be less to no competition and all companies would be able to charge a high price for their
product. They can do this by having all the companies reduce their supply of a product resulting
in a shortage, and a rise in the price. We have seen this in the real world with things such as oil.
When oil companies band together and form a cartel, they can limit other countries supply and
drive the price up. This inevitable will lead to higher prices for oil. We see this every time we go
to fill up our gas tanks. Cartels have a major flaw however; it leaves the door open for cheating.
One company might decide to raise their output because they think that if they are the only ones
to do so, it won’t make a big impact. They will be receiving benefits from those additional
outputs that the other companies wouldn’t be receiving. This wouldn’t affect the price of a
product too much, but all the other companies will see the larger economic profits, and will want
to do it as well. This will cause the price to drop by to its original level.
Externalities happen when buyers and sellers are not the only things being affected by the
production of a product. Externalities can be either positive or negative. One example is the
automobile. The output of a car (exhaust) is negatively affecting people who are in no way
involved in the buying or selling of the automobile. People will breathe in the fumes that can be
very harmful to their health. Externalities are not addressed when we graph the market curves.
Externalities relate back to a misallocation of resources that are being used to product the
product. Like we discussed before, this leads to allocative inefficiency. Marginal costs that
company faces are things such as wages, utilities, materials etc. Pollution from producing a
product is not weighed in. These things are paid for by others. When these factors are not
weighed in when we draw the market curves, it can lead to an over-production of a product. The
government has applied some ways for the companies to pay for such externalities. Imposing
pollution taxes are a way of doing so. This tax is only addressing the allocative inefficiency, not
the pollution itself. Not all externalities are negative, however. Our public education system has
a positive externality. Not only do students benefits from their education, the community does as
well. Higher educated people in society lead to higher paying jobs and a higher quality of life.
Educated people tend to commit a lot less crimes, and rely on the government far less than
uneducated people. When people are making more money, they pay more in taxes. The taxes that
are collected will them be recycled back into the community to help make it better.