Lecture 4: market and equilibrium

Advanced Micro TheoryMSc.EnviNatResEcon.

1/2006Charit Tingsabadh

Review of Economics Session 1

Markets and market processes

To create value, organisations need to understand their environment

Two levels of environment:• The contextual environment (remote/macro).• The transactional environment.

Markets are part of the organisation’s transactional environment

We look at markets in a broad, abstract way.

Analysis applies to commercial and not-for-profit organisations.

But remember that events and processes in the contextual environment impact the organisation through market forces.

Markets

For the moment, forget individual businesses

Think about the all suppliers - the “industry”

The market process

• A market is a process of interaction between buyers and sellers

• Both sides matter.

Objectives of market participants

• Consumers (demanders) seek to maximise value from the satisfaction of their wants and needs

• Producers (suppliers) seek to maximise added value

Demand and supply analysis

We can analyse markets using the notions of

Market demand

and

Market supply

These turn out to give us a tremendously powerful way of marshalling our thoughts.

Market demand for a product

… depends on customers’ willingness to pay it.

This, in turn, depends on

• tastes or preferences

• price relative to other products

• consumers’ income

Market supply of a good

… depends on the how many businesses are willing and able to sell products at various prices.

This, in turn, depends on

• input/raw material prices

• the state of technology

• the price of the good relative to the prices of other goods

MARKET EQUILIBRIUM

A market is in equilibrium when supply and demand are balanced, so that the price has no tendency to change from its current level.

Equilibrium Price and Quantity Traded

Price ofproduct

Quantity demanded/suppliedof product per time period

Q1

P1

S

D

Excess demand, excess supply and price adjustments

Price ofgood X

Quantity demanded/suppliedof good X per time period

Q1

P1

S

D

P2

Excess supply

QD Qs

Does this work for desktop PC’s?

Price ofPC

Quantity demanded/suppliedof PCs per time period

Q1

P1

S

D

CHANGES IN MARKET PRICE

ARISE FROM

Anything that changes the conditions of demand

or

Anything that changes the conditions of supply

An increase in demand

Price ofgood X

Quantity demanded/suppliedof good X per time period

Q1

P1

S

D1

D2

Q2 Q3

P2

LET US TRY TO DEDUCE WHAT HAPPENS TO MARKET PRICE IN THE

FOLLOWING CASES:

• The product has a successful advertising campaign (by all competitors together)

• The economy has an exchange rate appreciation

• Wage costs rise

• Technological progress takes place

Applications of market analysis

• The market for crude oil and supply side interruptions.

• The market for heroin: supply side and demand side interventions

• The UK National Health Service and waiting lists

$10

D

S, pre-warS, post-war

1990: The Gulf war and its effect on the price of crude oil

52Million barrels/day

$10

$40

D

S, pre-warS, post-war

1990: The Gulf war and its effect on the price of crude oil

5248 Mill b/day

The market for heroin

Price

Quantity per period

P1

Q1

Supply

Demand

The market for heroin

Price

Quantity per period

P1

Q1Q2

P2

Supply

Demand

The market for heroin

Price

Quantity per period

P1

Q1

P2

Supply

Demand

NewSupply

A private health service

Price

Quantity per period

P1

Q1

Market supply

Demand

A publicly provided health service

Price

Quantity per period

P1

Q1Q2

P2

Imputed market supply

Demand

Q*

A health service dilemma: more supply adds to demand

Price

Quantity per period

P1

Q1Q2

P2

Imputed market supply

Demand

New demand

Q3

Reading and further issues

Perman and Scouller, Business Economics, Chapter 2

Task 1

• Select one business that one organisation of which you are aware is involved in.

• What market does this business operate in?

Answer these questions for the market as a whole, not a single business

• Using PEST analysis, identify any important changes in external conditions that might affect market supply or demand.

• Which, if any, of these changes affect demand conditions in that market?

• Which, if any, of these changes affect supply conditions in that market?

• Using a supply and demand sketch diagram, illustrate how these changes might affect market demand and supply (this analysis need only be qualitative).

Chapter 9

Applying the Competitive Model

Figure 9.1 Consumer

Surplus

Figure 9.1a Consumer Surplus

Figure 9.1b Consumer Surplus

Figure 9.2 Fall in Consumer Surplus From Roses as Price

Rises

Table 9.1 Effect of a 10% Increase in Price on Consumer Surplus (Revenue and Consumer Surplus in Billions of

1999 Dollars)

Page 278 Solved Problem 9.1

Figure 9.3 Producer Surplus

Figure 9.3a Producer Surplus

Figure 9.3b Producer Surplus

Page 281 Solved Problem 9.2

Figure 9.4 Why Reducing Output from the Competitive Level Lowers

Welfare

Figure 9.5 Why Increasing Output from the Competitive Level Lowers

Welfare

Figure 9.6 Effect of a Restriction on the Number of

Cabs

Figure 9.7 Welfare Effects of a Specific Tax on Roses

Figure 9.8 Welfare Effects of a Per-Unit Subsidy on Roses

Figure 9.9 Effect of Pricing Supports in

Soybeans

Page 298 Solved Problem 9.3

Page 300 Solved Problem 9.4

Figure 9.10 Loss from Eliminating Free Trade

Figure 9.11 Effect of a Tariff (or Quota)

Table 9.2 Welfare Cost of Trade Barriers (millions of 1999 Dollars)

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