Midterm review 1. Some sample quiz questions 2. Some ideas on - - PowerPoint PPT Presentation

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

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

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.

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

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.

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

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

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

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

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

Find Airbus’ elasticity at PA = 24 …

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

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

Illustrate graphically

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

Pi Qi

10 20 30 40 30 60 90 120

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

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

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

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

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

Summary: Market demand versus Airbus’ demand

MARKET DEMAND Q = 120 − 2P

P Q

10 20 30 40 50 60 30 60 90 120

AIRBUS’ DEMAND

(If PB = 24 )

QA = 108 − 3PA

Pi Qi

10 20 30 40 50 60 30 60 90 120

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

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?

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

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

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

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

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

Falafel vendors on the beach of Lebanon

B e a c h

A B C D E F G H I J K P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 14

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

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 15

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.)

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 16

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

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 17

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

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 18

So find equilibrium …

(a) Q∗

i

(b) P∗ (c) Q∗ (d) N∗

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 19

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.

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 20

But then demand fluctuates

How does long-run equilibrium change?

4 8 12 16 20 24 28 1000 2000 3000

Lira (100s) Q

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 21

So find (long-run) equilibria …

(a) Q∗

i

(b) P∗ (c) Q∗ (d) N∗

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 22

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.

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 23

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??

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 24

Of an individual vendor?

What is medium-run supply?

4 8 12 16 20 24 28 100 200 300

Lira (100s) Q AC MC

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 25

Of the entire market?

What is medium-run supply?

4 8 12 16 20 24 28 1000 2000 3000

Lira (100s) Q

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Session R1 • Midterm Review Slide 26