Market Equilibrium

Market Equilibrium and Market Demand: Perfect Competition
Chapter 8
Discussion Topics
Derivation of market supply curve Elasticity of supply and producer surplus Market equilibrium under perfect competition Total economic surplus Adjustments to market equilibrium
Penson: Introduction to Agricultural Economics, 4th ed.
2006, Pearson Education, Upper Saddle River NJ, 07458. All Rights Reserved
Remember the firms supply curve?
P=MR=AR
Page 123
P=MR=AR
Firms supply curve starts at shut down level of output
Page 162
Penson: Introduction to Agricultural Economics, 4th ed. 2006, Pearson Education, Upper Saddle River NJ, 07458. All Rights Reserved
Profit maximizing firm will desire to produce where MC=MR
P=MR=AR
Page 162
Economic losses will occur beyond output OMAX, where MC > MR
P=MR=AR
Page 162
Building the Market Supply Curve
Market supply curve can be thought of as the horizontal summation of the supply decisions of all firms in the market. Here, at a price of $1.50, Gary would supply 2 tons of broccoli and Ima would supply 1 ton, giving a market supply of 3 tons.
Page 163
Page 163
Page 163
Merging Demand and Supply

Price
PE
Market clearing price
QE
Quantity

Price
PE Chapters 3-5
QE
Quantity

Price
D* D
PE* PE
Factors that change S demand: Other prices Consumer income Tastes and preferences Real wealth effect Global events
QE QE*
Quantity

Price
S
Chapters 6-7
PE
QE
Quantity

S* Price
PE* PE
Factors that change supply: Input costs Government policy Price expectations Weather & disease Global events
QE*QE
Quantity
Concept of Producer Surplus

Producer surplus is a fancy term economists use for profit. We measure producer surplus as the area above the supply curve and below the market equilibrium price.
Page 165
Concept of Producer Surplus

Producer surplus is a fancy term economists use for profit. We measure producer surplus as the area above the supply curve and below the market equilibrium price.
Total economic surplus is therefore equal to consumer surplus discussed in Chapter 4 plus producer surplus.
Page 165
Market Price of $4
Product price
Producer surplus at $4 is equal to area ABC
Page 165
Suppose Price Increased to $6
Product price
Producer surplus at $6 is equal to area EDC
Page 165
The gain in producer surplus if the price increases from $4 is equal to area AEDB
Producers are better off economically by responding to this price increase by producing output G
F G
Page 165
An Example of Economic Welfare Analysis
Assume a drought occurs that results in a decrease in supply from S to S*. Before this happened, consumer surplus was area 3+4+5 while producer surplus was equal to area 6+7. Total economic equals area 3+4+5+6+7
Page 169
After the decrease in supply, consumer surplus is just area 3. They lose area 4 and area 5. Producers gain area 4 but lose area 7.
Page 169
Consumers are therefore worse off because of the drought. Producers are also worse off if area 4 is less than area 7. Society loses area 5+7.
Page 169
Measuring Surplus Levels

$7
D
S
Consumer surplus is equal to (10 x (7-4))2, or $15
$4
Product price
$1 10
Page 168

$7
D
S
$4
Product price
$1 10
Producer surplus is Equal to (10 x (4-1))2, or $15
Page 168

$7
D
S
$4
Product price
$1 10
Producer surplus is Equal to (10 x (4-1))2, or $15
Total economic surplus is therefore $30
Page 168
Modeling Commodity Prices
Forecasting Future Commodity Price Trends

$7
D
S
D = a bP + cYD + eX
$4
Own price
Disposable income
Other factors
$1 10
Page 168
Forecasting Future Commodity Price Trends

$7
D
S
$4
Own price
Input costs
Other factors
S = n + mP rC + sZ
$1 10
Page 168
Projecting Commodity Price

$7
D
S
D = 10 6P + .3YD + 1.2X
$4
D=S
S = 2 + 4P .2C + 1.02Z
$1 10
Substitute the demand and supply equations into the the equilibrium condition and solve for Page price 221
Many Applications
Policy decisions by Congress
and the president Commodity modeling by brokers and traders Credit repayment capacity analysis by lenders Outlook presentations by extension economists Planting decisions by farmers Herd size and feedlot placement decisions by livestock producers Strategic planning for processors
Market Disequilibrium
Market Surplus
At the price is PS, producers would supply QS.
Page 170
Market Surplus
At the price is PS, consumers would only want QD.
Page 170
Market Surplus
At the price is PS, a market surplus equal QS QD exists
Page 170
Market Shortage
At the price is PD, producers would only supply QS.
Page 170
Market Shortage
Consumers want QD at this low price.
Page 170
Market Shortage
At C onsumers the price is PS, want a market QD at shortage this low price. equal QD QS exists
Page 170
Adjustments to Market Equilibrium

Markets converge to equilibrium over time unless other events in the economy occur. One explanation for this adjustment which makes sense in agriculture is the Cobweb theory. This names stems from the spider like trail the adjustment process makes.
Year Two Reactions
Producers use last years price as their expected price for year 2.
Consumers on the other hand pay this years price determined by Q2.
Page 172
Year Three Reactions
P3
P2
Producers now decide to produce less at the lower expected price. This lower quantity pushes price up to P3 in year 3.
Page 172
Cobweb Pattern Over Time
Market equilibrium
The market converges to market equilibrium where demand intersects supply at price PE. In some markets, this adjustment period may only be months or even weeks rather than years assumed here.
Page 172
Market-to-Firm Linkages
Some Important Jargon

We need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve.
Some Important Jargon

We need to distinguish between movement along a demand or supply curve, and shifts in the demand or supply curve. Movement along a curve is referred to as a change in the quantity demanded or supplied. A shift in a curve is referred to as a change in demand or supply.
Increase in demand pulls up price from Pe to Pe*

Decrease in demand pushes price down from Pe to Pe* Page 167

Increase in supply pushed price down from Pe to Pe*

Decrease in supply pulls up price from Pe to Pe* Page 167


Price
S
Chapters 6-7
PE Chapters 3-5
QE
Quantity
Firm is a Price Taker Under Perfect Competition

Price The Market
Price
AVC
The Firm
MC
PE
QE Quantity
OMAX
If Demand Increases
The Market Price
D D1
The Firm
Price
AVC MC
PE
QE Quantity
10 11
If Demand Decreases
The Market Price D2 The Firm
Price
AVC MC
PE
QE Quantity
9 10
Firm is a Price Taker in the Input Market

Price Labor Market D S
Price
The Firm MVP
PE
MIC
QE Quantity
LMAX
Firm is a Price Taker in the Input Market

Price
The Firm MVP
PE
MIC
QE Quantity
LMAX
Effects of Increasing The Minimum Wage

Price
The Firm MVP
PMIN MIC
QD QS Quantity
LMAX
Summary
Market equilibrium price and quantity
are given by the intersection of demand and supply Producer surplus captures the profit earned in the market by producers Total economic surplus is equal to producer surplus plus consumer surplus A market surplus exists when the quantity supplied exceeds the quantity demanded. A market shortage exists when the quantity demanded exceeds the quantity supplied.
Chapter 9 focuses on market equilibrium and product prices under conditions of imperfect competition.

Market Equilibrium

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Market Equilibrium

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Market Equilibrium and Market Demand: Perfect Competition

Penson: Introduction to Agricultural Economics, 4th ed.

Remember the firms supply curve?

Penson: Introduction to Agricultural Economics, 4th ed.

Firms supply curve starts at shut down level of output

Profit maximizing firm will desire to produce where MC=MR

Economic losses will occur beyond output OMAX, where MC > MR

Building the Market Supply Curve

Building the Market Supply Curve

Building the Market Supply Curve

Merging Demand and Supply

Market clearing price

Merging Demand and Supply

Merging Demand and Supply

Merging Demand and Supply

Merging Demand and Supply

Concept of Producer Surplus

Concept of Producer Surplus

Producer surplus at $4 is equal to area ABC

Suppose Price Increased to $6

Producer surplus at $6 is equal to area EDC

An Example of Economic Welfare Analysis

An Example of Economic Welfare Analysis

An Example of Economic Welfare Analysis

Measuring Surplus Levels

Consumer surplus is equal to (10 x (7-4))2, or $15

Measuring Surplus Levels

Consumer surplus is equal to (10 x (7-4))2, or $15

Producer surplus is Equal to (10 x (4-1))2, or $15

Measuring Surplus Levels

Consumer surplus is equal to (10 x (7-4))2, or $15

Producer surplus is Equal to (10 x (4-1))2, or $15

Total economic surplus is therefore $30

Modeling Commodity Prices

Penson: Introduction to Agricultural Economics, 4th ed.

Forecasting Future Commodity Price Trends

Forecasting Future Commodity Price Trends

Projecting Commodity Price

Penson: Introduction to Agricultural Economics, 4th ed.

Penson: Introduction to Agricultural Economics, 4th ed.

At the price is PS, producers would supply QS.

At the price is PS, consumers would only want QD.

At the price is PS, a market surplus equal QS QD exists

At the price is PD, producers would only supply QS.

Consumers want QD at this low price.

Adjustments to Market Equilibrium

Penson: Introduction to Agricultural Economics, 4th ed.

Year Two Reactions

Year Three Reactions

Cobweb Pattern Over Time

Penson: Introduction to Agricultural Economics, 4th ed.

Some Important Jargon

Penson: Introduction to Agricultural Economics, 4th ed.

Some Important Jargon

Penson: Introduction to Agricultural Economics, 4th ed.

Increase in demand pulls up price from Pe to Pe*

Decrease in demand pushes price down from Pe to Pe* Page 167

Increase in supply pushed price down from Pe to Pe*

Decrease in supply pulls up price from Pe to Pe* Page 167

Merging Demand and Supply

Firm is a Price Taker Under Perfect Competition

Firm is a Price Taker in the Input Market

The Firm MVP

Firm is a Price Taker in the Input Market