unit 8 Flashcards
what happens if a price is set above the equilibrium
there will be excess supply as more sellers want to sell but not all will find a buyer so they will lower price
what happens if price is set below equilibrium
Excess demand so some buyers may offer more to ensure that they get the product thus price goes back to equilibrium
what is competitive equilibrium (5)
when price and quantity remain the same
All transactions take place at the same price - law of one price
The market clears S=D
buyers and sellers are price takers
its Nash equilibrium as nobody could do better without making someone else worse off
Conditions for competitive equilibrium (3)
Many buyers and sellers
Identical goods
Perfect knowledge
why can competitive equilibrium be useful
it tells us the maximum surplus available in the market.
what does the demand curve show
Willingness to pay (WTP) = the amount of money a consumer would be willing to pay for a good.
what does the market supply curve
Willingness to accept (WTA) = the amount of money the seller would be willing to trade the good for, also referred to as the seller’s reservation price
what is a price taker
A price taker accepts the market price and chooses quantity depending on marginal cost
what happens to the profit maximising quantity when price changes
If the price falls below marginal cost you should immediately stop producing as you lose out on every unit produced
If the price rises above marginal cost of producing additional units then the, maximising quantity expands so production should increase
what is the marginal cost function
it is the firms supply curve:
- it tell you the quantity to produce at each level of the market price
- profit maximisation is when MC = market price
how do you find market supply curve
add up the total amount of all firms producing that product at each price
what do supply curves tell us (3)
At a given price how much will be produced
At a given quantity we can find the marginal cost
Market supply curve is the marginal cost curve for all of the same products produced in an area
when are potential gains exhaust
at competitive equilibrium total surplus is maximised
the last loaf produced is equal to the WTP of the last customer who buys
what would occur if less of a product was produced
less gains from trade: some consumers would be WTP more than the cost of producing another loaf
what would occur if more of a product was produced
total surplus would decrease as surplus on extras units would be negative and would cost more to make then consumers WTP
what differs in price taking and price setting firms
price taking: at equilibrium total surplus is maximised
price setting: there is a deadweight loss as producers set a price above MC of the last item produced.
is equilibrium for price taking firms Pareto efficient
yes because we cannot change the allocation to make a consumer or firm better off without making the other worse
when does Pareto efficiency hold in a compatative market (4)
In a market with many buyers and sellers of identical goods
At equilibrium where participants are price takers
When trade has no external effects
When there is a complete contract between each buyer and seller
is the price taking model realistic?
Most firms sell goods that are somehow differentiated from those of other firms and service and range of goods they offer
Price taking is rare
Many goods have external effects e.g. co2 emissions
Contracts are often
incomplete
what teo things do we use to access an allocation
efficiency and fairness
what does the distribution of total surplus depend
it depends on relative elasticity of demand and supply
what happens when demand for a good increases
new equilibrium is reached where sellers sell at a higher price and to more customers
if supply curve was steeper the price would rise more and quantity would increase less.
If the supply curve was flat then price rise would be smaller and quantity increased would be larger
sellers now earn economic rent as profits are higher than necessary to keep the business going
what can shifts in demand be called
exogenous shocks
what happens if market is not in equilibrium
buyers and sellers can act as price makers to earn disequilibrium rents until equilibrium is reached
what happens when supply rises
more is sold at a lower price
Supply curve shifts downwards as marginal cost is reduced at each level of output
Supply shifts to the right, as costs have fallen, the firm can supply more at each price.
there is excess supply so firms benefit from lowering prices to sell more
what do average cost curves show
they show fixed costs, not only marginal costs
what occurs if long run equilibirum is reached
rent seeking and competition will eliminate less efficient firms.
The firms remaining have low average cost and normal profits.
The market remains here unless there is a big change in demand or supply
why did oil prices increase
prices increased due to OPEC controlling a large proportion of global oil resources and working as a cartel, restricting access to middle east oil.
why is sustaining a cartel hard
If a single company chooses to charge a lower price to eliminate competition then the cartel falls apart and consumers get lower prices.
why may a government impose a tax
to raise revenue to finance public expenditure and to redistribute resources and reduce inequality
If a 30% tax is imposed on suppliers what are the effects on suppliers
suppliers marginal costs are 30% higher at each quantity so the supply curve shifts, but not in a parallel manner as the dollar paid in tax increases with quantity produced
what are the effects of government tax on surplus
Consumer surplus falls: they pay a higher price and buy less salt
Producer surplus falls: producers supply less and receive a lower net price
Total surplus is lower: the tax causes a deadweight loss
what goods to governments prefer to tax and why
the government would prefer to tax goods with low elasticity of demand so the fall in quantity is small, this means the tax affects mostly consumers.
This is to raise as much revenue as possible and reduce DWL
why might governments intervene when there is market clearing price
to achieve other objectives e.g. fairness
why may governments control the housing rent prices
to protect tenants who have little bargaining power with the landlords.
It could also be because rent may be too high for groups of workers that provide essential services
