[PDF] - Midterm review 1 1. Some sample quiz questions 2. Some ideas on PDF Document

SLIDE 1

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 1

1 Midterm review

1. ➥ Some sample quiz questions

2. Some ideas on elasticity of demand
3. An exercise on (a) medium run and (b) long run

2 Sample quiz question

Which of the following hold (in equilibrium) for an individual firm in the model of perfect competition?

a. Its marginal revenue is less than the market price.
b. It never earns an economic profit.
c. Its marginal cost equals its marginal revenue.

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 2

3 Sample quiz question

Which statements about the inefficiency of the decisions of a firm with market power are true, in the models we have studied?

a. The firm has no incentive to reduce its cost of production.
b. The firm will produce too much in order to take over market share.
c. The firm may forgo projects that have positive net social value.

4 Midterm review

1. ✓ Some sample quiz questions 2. ➥ Some ideas on elasticity of demand

3. An exercise on (a) medium run and (b) long run

SLIDE 3

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 3

5 Scenario

From “Exercise on Demand and Elasticity”

Product category: Passenger jets. Dominated by two firms: Airbus (A) and Boeing (B). (For simplicity, imagine that each firm produces one kind of jet, and these two jets make up the entire product category.) Hypothetical demand functions: QA = 60 − 3PA + 2PB QB = 60 − 3PB + 2PA

6 Find Airbus’ elasticity at PA = 24 …

when Boeing’s price is PB = 30 : And when PB = 24 ?

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 4

7 Illustrate graphically

Graph Airbus’ demand curve when PB = 24 and when PB = 30 :

Pi Qi

10 20 30 40 30 60 90 120

8 Market demand

Market demand: How does aggregate demand for the entire product category respond when the prices of all products in the category go up? Aggregation problem: Need to define …

QA= 60 − 3PA + 2PB QB= 60 − 3PB + 2PA

aggregate output
a price index

Our numerical example is easy. We can just add the two quantities: Q = QA + QB For a price index, we use the average price: P = PA + PB 2

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 5

9 Aggregation: Calculation

Aggregate demand Q as a function of the average price P ? QA = 60 − 3PA + 2PB QB = 60 − 3PB + 2PA

QA + QB = (60 − 3PA + 2PB) + (60 − 3PB + 2PA)

= 120 − PA − PB

Q

= 120 − 2 PA + PB

2

P

⇒ Q = 120 − 2P

10 Summary: Market demand versus Airbus’ demand

MARKET DEMAND Q = 120 − 2P

P Q

10 20 30 40 50 60 30 60 90 120

(From slide 18)

AIRBUS’ DEMAND

(If PB = 24 )

QA = 108 − 3PA

Pi Qi

10 20 30 40 50 60 30 60 90 120

(From slides 15 & 16)

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 6

11 Comparing the elasticities

Calculate the elasticity of the market demand curve at P = 24 :

From Q = 120 − 2P , choke price is ¯

P = 60 :

= ⇒

E = 24 60 − 24 = 24 36 = 0.67

It is much lower than the elasticity of Airbus’ demand curve at PA = 24 , given PB = 24 . Intuition?

12 Broader idea

This illustrates a broader idea brought up in Session 3: The more we aggregate across products, the less elastic is demand. For example: demand for computer monitors less elastic than demand for LCD monitors less elastic than demand for Acer LCD monitors less elastic than demand for the Acer AL1916 19” widescreen monitor

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 7

13 Midterm review

1. ✓ Some sample quiz questions 2. ✓ Some ideas on elasticity of demand 3. ➥ An exercise on (a) medium run and (b) long run

14 Falafel vendors on the beach of Lebanon

B e a c h

A B C D E F G H I J K

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 8

15 An illustration of these ideas … for perfect competition

1. For individual firm:
Supply decision, when in market, depends only on marginal cost.
Fixed cost drives exit/entry decision.
2. But at level of the market (equilibrium)

Fixed costs ⇒ exit/entry decisions ⇒ market prices

16 How we do this

For case of identical firms (free entry) … Study adjustments following a shift in demand:

1 Long run given initial demand curve.

2 Medium run after shift in demand.

3 Long run after shift in demand.

(We did this in Session 6 for an increase in fixed cost.)

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 9

17 A falafel vendor on the beach of Lebanon

Typical cost structure:

4 8 12 16 20 24 28 100 200 300

Lira (100s) Q AC MC

18 Assume free entry

Draw approx. aggregate supply curve and show equilibrium.

4 8 12 16 20 24 28 1000 2000 3000

Lira (100s) Q Demand: Q = 3000 − 100P

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 10

19 So find equilibrium …

(a) Q∗

i

(b) P∗ (c) Q∗ (d) N∗

20 How we do this

For case of identical firms (free entry) … Study adjustments following a shift in demand:

1 ✓ Long run given initial demand curve.

2 Medium run after shift in demand.

3 ➥ Long run after shift in demand.

SLIDE 11

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 11

21 But then demand fluctuates

How does long-run equilibrium change?

4 8 12 16 20 24 28 1000 2000 3000

Lira (100s) Q

22 So find (long-run) equilibria …

(a) Q∗

i

(b) P∗ (c) Q∗ (d) N∗

SLIDE 12

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 12

23 How we do this

For case of identical firms (free entry) … Study adjustments following a shift in demand:

1 ✓ Long run given initial demand curve.

2 ➥ Medium run after shift in demand.

3 ✓ Long run after shift in demand.

24 But suppose entry and exit take time …

Think of long run as after exit/entry; medium run is before exit/entry. What are medium-run supply decisions and equilibrium??

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P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Page 13

25 Of an individual vendor?

What is medium-run supply?

4 8 12 16 20 24 28 100 200 300

Lira (100s) Q AC MC

26 Of the entire market?

What is medium-run supply?