ANTITRUST ECONOMICS 2013 David S. Evans University of Chicago, Global Economics Group Elisa Mariscal CIDE, ITAM, CPI TOPIC 3: DEMAND SUPPLY & STATIC COMPETITION Date Topic 3 Part 1 7 March 2013
Overview 2 Part 1 Part 2 Demand, Supply and Perfect Competition Changes in perfectly competitive markets Analyzing changes in perfectly competitive markets Consumer and Social Welfare Consequences Merger to Monopoly
3 Demand, Supply and Perfect Competition
4 What is Perfect Competition? Goods are all the same homogenous demand, no product differentiation: basically commodity markets. Firms are all small so none has any power over price they all face a perfectly elastic individual demand: atomistic competition. Information is widely available so everyone knows the prices being charged and paid. Transaction costs are zero, eliminating any advantages one firm might have over another.
5 Costs curves and profit maximization P MC ATC AVC Q ATC Average Total Cost Curve. AVC Average Variable Cost Curve. MC Marginal Cost Curve.
Typical Firm in the Short Run Equilibrium 6 Costs MC ATC P Supply AVC P* = MR P* Demand q f Q The supply curve is the upward slopping part of the MC curve that lies above the AVC curve. The firm will not operate on points on the MC curve below the AVC curve since it could have higher profits by shutting down. Q M Q
7 Why is equilibrium the point where Supply and Demand intersect? P Excess supply Supply What if price were above the equilibrium? P XES At that price, quantities demanded would be less than quantities offered. Q D Q S Demand Q The firm has an incentive to reduce price and eliminate the extra quantity in the market Consumers will be willing to demand additional quantities as price falls
8 Why is equilibrium the point where Supply and Demand intersect? P Supply What if price were below the equilibrium? At that price, quantities demanded would be greater than quantities offered. P XED Excess demand Q S Q D Demand Q The firm has an incentive to increase price and offer additional quantities in the market As price rises, consumers will be less willing to pay for additional quantities
9 Typical Firm in the Short Run Equilibrium P MC 3 Supply P 3 MC 1 MC 2 AVC 3 AVC 2 P 2 P 1 AVC 1 q 1 q 2 Q q 3 The supply curve is the horizontal sum of the marginal cost curves for those firms that find it profitable to be in the market and produce at those prices (where MC>AVC).
10 Typical Firm in the Short Run Equilibrium P MC 3 Supply P 3 MC 1 MC 2 AVC 3 P * AVC 2 P 2 P 1 AVC 1 q 1 q 2 Q q 3 Demand The supply curve is the horizontal sum of the marginal cost curves for those firms that find it profitable to be in the market and produce at those prices (where MC>AVC). Example of perfect competition with three firms that vary in their levels of efficiency.
11 Typical Firm in the Short Run Equilibrium P MC 3 Supply P 3 MC 1 MC 2 AVC 3 P * AVC 2 P 2 P 1 AVC 1 Demand Q 1 Q 2 Q 1 +Q 2 Q The supply curve is the horizontal sum of the marginal cost curves for those firms that find it profitable to be in the market and produce at those prices (where MC>AVC). Example of perfect competition with three firms that vary in their levels of efficiency. Entry takes place until price equals marginal cost and the marginal firm just breaks even. Firm 3 is not efficient enough to compete in this market. It would enter at a price of P 3
12 Analyzing Changes in Perfectly Competitive Markets
The effect of an increase in demand 13 Assuming we draw only MC> AVC P MC 2 MC 3 Supply MC 1 P1 Q 1 Q 1 +Q 2 Q Q 2 Demand 1 A demand increase could be caused by an increase in consumer income.
The effect of an increase in demand 14 Assuming we draw only MC> AVC P MC 2 MC 3 Supply MC 1 P2 P1 Demand 2 Q 1 Q 1 +Q 2 Q Q 2 Demand 1 A demand increase could be caused by an increase in consumer income.
The effect of an increase in demand 15 Assuming we draw only MC> AVC P MC 2 MC 3 Supply MC 1 P2 P1 Demand 2 Q 1 Q 1 Q Q 1 +Q 2 +Q 3 2 Q 2 Q 3 Q Demand 1 A demand increase could be caused by an increase in consumer income. Demand increases, price rises, inframarginal firms enter the market, and existing firms expand.
The effect of costs increases 16 Assuming we draw only MC> AVC P MC 1 MC 2 MC 3 Supply P1 Q 1 Q 2 Q 1 +Q 2 Demand 1 Q
The effect of costs increases 17 Assuming we draw only MC> AVC P MC 1 MC 2 MC 1 MC 2 MC 3 MC 3 Supply P2 P1 Q 1 Q 2 Q 1 +Q 2 Demand 1 Q Costs can increase perhaps from a rise in the cost of a key input.
The effect of costs increases 18 Assuming we draw only MC> AVC P MC 1 MC 2 MC 1 MC 2 MC 3 MC 3 Supply P2 P1 Demand 1 Q 1 Q 1 Q 2 Q 2 Q 1 +Q 2 Q 1 +Q 2 Q Costs can increase perhaps from a rise in the cost of a key input. When all costs increase, supply falls and price rises. This counters some of the fall in supply. Marginal firms exit the business and other firms contract.
19 Economists use this framework to do comparative statics What would happen to prices and output if: The costs of inputs increases? New products enter the market? Your product becomes popular? Competitors exit the market? The government levies a tax on each unit you sell? All of these events will cause shifts and movements along the demand and supply curves until a new equilibrium is achieved where S = D. Let s take a look at some examples:
20 The effect of a $1 unit tax $ 7 Initial equilibrium $ 6 Supply 1 Price per Pint $ 5 $ 4 $ 3 $ 2 $ 1 $ 0 0 1 2 3 4 5 6 7 8 9 10 Pints of Beer Demanded (Millions per Year) Demand 1
21 The effect of a $1 unit tax the increase in price is less than the $1 tax $ 7 $ 6 Supply 2 (with $1 tax) Supply 1 Tax payed by consumers Tax payed by producers Price per Pint $ 5 $ 4 $ 3 $ 2 $ 1 $ 0 0 1 2 3 4 5 6 7 8 9 10 Pints of Beer Demanded (Millions per Year) Demand 1 Results: Price rises but by less than the amount of the $1 tax and ouput falls.
22 The effect of unit tax Why do prices not increase by the total amount of the tax? It has to do with elasticities again. For a given supply schedule, producers carry more of the burden of the tax increase the more elastic is demand For a given demand schedule, producers carry more of the burden of the tax increase the more inelastic is supply.
23 There is an increase in demand $ 7 $ 6 Initial equilibrium Supply 1 Price per Pint $ 5 $ 4 $ 3 $ 2 $ 1 $ 0 0 1 2 3 4 5 6 7 8 9 10 Pints of Beer Demanded (Millions per Year) Demand 1
24 There is an increase in demand $ 7 Supply 1 Price per Pint $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 $ 0 0 1 2 3 4 5 6 7 8 9 10 Pints of Beer Demanded (Millions per Year) Demand 2 (advertising affects preferences) Demand 1 Let s suppose that demand increases due to advertising. Result: Price rises and output rises
25 A cheaper substitute makes demand more elastic $ 7 $ 6 Initial equilibrium Supply 1 $ 5 Price per Pints $ 4 $ 3 $ 2 $ 1 Demand 1 $ 0 0 1 2 3 4 5 6 7 8 9 10 Pints of Beer Demanded (Millions per Year)
26 A cheaper substitute makes demand more elastic $ 7 Supply 1 $ 6 $ 5 Price per Pints $ 4 $ 3 $ 2 $ 1 $ 0 0 1 2 3 4 5 6 7 8 9 10 Pints of Beer Demanded (Millions per Year) Demand 1 Demand 2 (with substitute) Result: Demand schedule becomes flatter. Price falls and output falls.
27 End of Part 1, Next week Part 2 Part 1 Part 2 Demand, Supply and Perfect Competition Changes in perfectly competitive markets Analyzing changes in perfectly competitive markets Consumer and Social Welfare Consequences Merger to Monopoly