Notes 04

Notes 04 - Notes 04 Introductory Microeconomics III...

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Notes 04 – Introductory Microeconomics III. COMPETITIVE MARKET EQUILIBRIUM In a competitive market neither the individual suppliers nor demanders believe that their actions will affect the market price. Competitive market equilibrium occurs at the point where the supply and demand curves intersect. The intersection of the supply and demand curves determines both the equilibrium price and the equilibrium quantity. At the equilibrium price (or market clearing price) the quantity supplied equals the quantity demanded, so neither group has an incentive to change their behavior. At any other price there is a discrepancy between the quantities demanded and supplied. The following diagram indicates the competitive equilibrium. Quantity P* Q* S(w, τ ,Z) D(Px,I,X) CS PS Price GAIN FROM TRADE: Gains from trade (GFT) is equal to the Total value minus Total Cost. GFT=TV-TC. However, if there are no taxes or subsidies – as in all examples so far – then GFT is also equal to the sum of consumer surplus and producer surplus. This can be verified from the following algebraic manipulation: PS CS TC TR TE TV TC Q P Q P TV TC Q P Q P TV TC TV GFT = + = + = + = = ) ( ) ( ) * ( ) * ( * * EFFICIENT POINT: The efficient point is where the GFT are maximized. Gains from trade are equal to total value (the area below the demand curve) minus total cost (the area below the supply curve). Intuitively, if we were interested in maximizing the gains from 1

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trade, we would continue to increase output as long as MV was greater than MC (if MV>MC then GFT increases with more output). We would continue to increase output until the point where MV=MC – where the supply and demand curves cross. Notice that at the competitive market equilibrium, gains from trade are maximized. If fewer units were produced and consumed, both consumer and producer surplus would decrease, decreasing GFT. If more units were produced and consumed, both consumer and producer surplus would decrease. This is an extremely powerful feature of competitive market equilibrium; without any government involvement, a free market arrives at an equilibrium that maximizes the gains from trade. This implies that if a government interferes in a competitive market, there are only two resulting possibilities: that the government will have no effect, or that it will decrease the gains from trade. Note that neither consumers or producers are attempting to maximize GFT – consumers
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This note was uploaded on 10/07/2008 for the course ECON 1110 taught by Professor Wissink during the Fall '06 term at Cornell.

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Notes 04 - Notes 04 Introductory Microeconomics III...

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