How do Supply & Demand Get
Together to Make Markets?
Agenda:
I.
What is Competition?
II. Birds & Bees Review
A. Where do demand curves come from?
B. Where do supply curves come from?
C. Industry supply curves (new math!)
III. How do demand and supply get together to make
markets?
A. Assumptions underlying perfect competition
B. A continuum of competition
What does “competition” mean to you?
So Where DO Demand Curves Come From?
composite
good
Price
What is the price of shelter at this budget constraint?
KEY:
Pay attention
to what is on
the X and Y
axes!
At this price, what is the optimal quantity of shelter?
Test yourself: Does demand
have anything to do with the
number of competitors in the
market?
quantity
xi xiU
xi

 xi
pi pi
M
Slutsky & Elasticity
Re-write the way we have written elasticities with x = Q for quantity of X
Qi Q
Qi

 Qi
pi
pi
M
U
i
Multiply both sides by P/Q, the last term by M/M and re-arrange M and Q
Qi P Q P PQi Qi M


pi Q pi Q M M Q
U
i
Own price elasticity = compensated price elasticity – share of income * income elasticity
Test yourself: Pick a product/service and draw the demand as a
function of both the substitution and income effects.
MARKET demand curves sum individual demand curves.
Larger substitution &
income effects
Smaller substitution &
income effects
Where Do Supply Curves Come From?
Supply Curves are MC curves ABOVE the minimum AVC!
Why not here??
What if price
is here?
Short-run
Individual
firm supply
curve
Economic loss!
Shutdown!
P<AVC
Test yourself: Does the supply curve have anything to do with fixed costs?
Market Supply Curve
The market supply is simply the sum of the
individual firm supplies!
P c

Firm Supply curve: P  c  dQ
Quantity: Q 
d d
P cn

Industry Supply: Q   Qn 
dn dn
n
100 firms each have identical supply curves: P = 5 + 200Q
What is the industry supply curve?
TEST YOURSELF:
What if firms did NOT have
identical supply curves?
1. Solve for Q
2. Multiply by n
3. Solve for P
P 5
Q
200
 P 5
Q  100 

 200 
P  5  2Q
Price Depends on Assumptions!
1. Are Products THE SAME (standardized, commodities)?
2. Are there barriers to firms entering or exiting?
3. Are there a lot of buyers and sellers?
4. Is there perfect information
(no transactions costs)?
A Continuum of Competition….
Key questions:
1. Is there meaningful product differentiation?
2. Are there significant barriers to entry or exit?
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly