P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
Page 1
Perfect competition with real firms
1
Topic 3
Isolate entry/exit
Topic 4
Isolate quantity
Topic 5
Combine entry/exit & quantity
How
Fix size of a firm,
only decision is whether to enter
Fix which firms are in the market,
only decision is how much to prod.
Firms decide both whether to enter
and how much to produce
Individual
firm
Entry ← break-even price
(economic cost)
Quantity ← MC
Entry ← AC
Quantity ← MC
MCi ↔ Supplyi
€
Re-interpret unit supply from
Sessions 1 & 2 as entry
€
MC
50
40
40
AC
30
ACu
20
20
10
10
Aggregate
supply
Supply goes up via
entry of new firms
Qi
30
5
Supply goes up via expansion
of output by firms in market
$
45
MC↔supply
40
20
20
25
30
35
Q
Supply goes up via entry
and expansion of firms in market
MC ↔ Supply
€
10 u 15
Q
P
30
35
25
30
40
25
20
20
15
15
20
10
10
5
5
5
2
10
15
20
25
30
Q (100MW)
100
200
300
Q
Q
100
This picture always holds
$
Consumer surplus
MC ↔ Supply
P ∗ → 35
Producer
surplus
MV ↔ Demand
Q ∗ → 50
Q
200
300
400
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
3
6. Applications of Perfect Competition
➥ 1. Market dynamics.
2. Simulation results.
3. Bagels and Cranberries (“Growth and Profitability”).
4
Long-run dynamics
$
60
S long
50
P 2∗ → 40
P 1∗ →
30
20
D2
10
D1
10
20
30
40
50
60
70
80
90
Q
Page 2
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
5
Firms’ short-run responses to price changes
$
60
S long
50
40
P 1∗ →
30
20
10
D1
10
6
20
30
40
50
60
70
80
90
Q
Short-run vs. long-run price adjustment
$
S short
60
S long
50
40
30
20
D2
10
D1
10
20
30
40
50
60
70
80
90
Q
Page 3
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
7
Bottom line
Whatever the source of adjustment delays and costs:
Adjustment delays and costs imply that supply adjusts less in the
short run than in the long run—hence, prices are more volatile in
the short run than in the long run.
8
Interpreted as delays for entry
$
S short
60
S long
50
40
30
20
D2
10
D1
10
20
30
40
50
60
70
80
90
Q
Page 4
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
9
Page 5
Price and capacity dynamics in a competitive industry
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(Courtesy of David Besanko.)
10
Bulk shipping
Bulk shipping: vessels designed to carry a homogeneous unpacked dry or
liquid cargo, for individual shippers on non-scheduled routes.
• Common cargo: iron ore, grain, coal, bauxite, phosphates, steel,
cement, sugar, wood chips.
• “Taxis, not buses”. (Entire cargo belongs to one shipper.)
• 72% of world seaborn trade (by weight).
(Data is thanks to Myrto Kaloupsidi.)
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
11
Market structure
12
Shipping prices
Page 6
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
13
Demand volatility
Maarket is characterized by demand volatility due to changing export
patterns, macroeconomic cycles.
14
Elasticity
1. Transportation costs are a small portion of total cost for most goods
(e.g. for gasoline $0.07 per gallon).
2. Few short-run substitutes.
3. Disruptions are costly:
• “Just-in-time” inventory models
• “Continuous-flow” refining
So what?
Page 7
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
15
Demand volatility
Demand: inelastic and volatile
+
Supply: inelastic
⇓
Volatile prices
16
6. Applications of Perfect Competition
✓ 1. Market dynamics.
➥ 2. Simulation results.
3. Bagels and Cranberries (“Growth and Profitability”).
Page 8
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
17
6. Applications of Perfect Competition
✓ 1. Market dynamics.
✓ 2. Simulation results.
➥ 3. Bagels and Cranberries (“Growth and Profitability”).
18
6. Applications of Perfect Competition
✓ 1. Market dynamics.
✓ 2. Simulation results.
✓ 3. Bagels and Cranberries (“Growth and Profitability”).
Page 9
P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets
Session 6 • Applications of Perfect Competition
19
This week
(Wed) Session 7: Elasticity of demand
• Prep Guide 8.
• FPM Ch. 8.
• A demand estimation exercise to hand in.
(Fri) Session 8: Pricing with Market Power
• Prep Guide 7.
• FPM Ch. 7.
20
Reminder: Next week you have …
… optional review and quiz.
Monday
Tuesday
Wednesday
Thursday
Friday
Session 9
Review
Quiz
Session 10
–
Quiz covers only up through Session 8.
Page 10
Total cost:
One way to approach your task in rounds 1 and 2:
€
1. Predict a market price P .
10000
c(Q)
2. Decide how much to produce at this price: s i (P) .
3. Back out inputs needed to produce this amount.
5000
Supply curve? Derive from cost curve.
Cost curve? Derive from production function.
100
200
300
Q
Marginal cost / Supply:
Individual firm:
€
Production function:
Derive cost curve:
Marginal cost:
Inverse is supply curve:
f (L, M) = L
1/3
M
⇓
c(Q) = 2Q 3/2
1/3
90
60
⇓
mc(Q) = 3Q 1/2
mc(Q) , s i (P)
30
⇓
s i (P) = P 2 /9
100
200
300
Q
Higher level question – how to predict P ?
Forecasts
Individual
supply
Market
price
Aggregate
supply
Equilibrium: s(P) = d(P) .
Supply / Demand / Equilibrium:
Equilibrium:
Total supply:
39 × s i (P)
⇒
39 2
P
s(P) =
9
Equil. solves:
s(P) = d(P)
⇒
P ∗ = 27.42
€
90
60
s(P)
Back to you:
You choose:
Back out inputs:
Q i = s i (P ∗ )
⇒
Q i = 83.5
from f
⇒
L = M = 763.5
30
d (P)
3000
6000
9000
Q
Following the shift in demand …
Short-run problem (Round 3):
Machines are fixed at their round-2 level.
Long-run problem (Rounds 4, 5):
Both inputs are adjustable.
New Long-run Equilibrium:
Long-run adjustment:
New demand:
Equilibrium:
d new (P) = 8970 − 100P
s(P) = d new (P)
⇒
€
90
New long-run
equilibrium
Pnew = 35.40
60
s(P)
Back to you:
You choose:
Back out inputs:
Q i = s i (Pnew )
from f
⇒
⇒
Q i = 5430
30
d (P)
L 4 = M 4 = 1643
3000
6000
d new (P)
9000
Q
Short-run production (round 3):
Total cost:
€
Stuck with:
10000
Mcurr = 763.5
c(Q)
c%(Q)
1/3
Short-run prod. function
Q = L 1/3 Mcurr
! "# $
5000
invert
⇓
Q3
L=
Mcurr
Labor requirements:
100
Short-run costs (round 3):
Total cost:
Q3
c%(Q) = Mcurr +
Mcurr
90
short-run
fixed cost
60
&
Marginal cost: mc(Q)
=
(Invert P = MC)
Supply:
⇓
%
s i (Q) =
300
Q
Marginal cost / Supply:
(% = short-run values)
short-run
variable cost
200
€
& s (Q) , %
mc
s i (P)
3
Q2
Mcurr
mc(Q) , s i (P)
30
'
Mcurr
P
3
100
200
300
Q
Short-run equilibrium:
Short-run equilibrium (round 3):
Total supply:
€
ŝ(P) = 39 × %
s i (P)
Equilibrium: %s (P) = dnew (P)
%
s (P)
90
⇒
P% = 47.03
⇒
% i = 109.4
Q
Short-run
equilibrium
60
Back to you:
You choose:
Back out inputs:
%i = %
%
Q
s i ( P)
from f
⇒
30
L 3 = 1715
3000
d (P)
d new (P)
6000
9000
Q
Short-run and Long-run Equilibria:
€
%
s (P)
90
60
s(P)
30
3000
d (P)
d new (P)
6000
9000
Q
Short-run and Long-run Equilibria:
Short-run and Long-run Equilibria:
€
%
s (P)
90
Round
1, 2
3
4, 5
P
Qi
Li
Mi
27.42 83.5 763.5 763.5
47.03 109.4 1715
35.40 139.2 1643 1643
60
s(P)
47.03
35.40
27.42
3000
What Actually Happened:
d (P)
d new (P)
6000
9000
Q
What Actually Happened:
€
%
s (P)
90
Round
1
2
3
4
5
P
Qi
29.82 77
28.41 81
47.59 108
37.42 134
34.18 142
60
s(P)
R3
R2
R1
3000
R4
R5
d (P)
d new (P)
6000
9000
Q