CHAP3 - Price Determination: Interaction of Supply and...

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1 Chapter 3 Price Determination: Interaction of Supply and Demand Economics is the only field in which two people can share a Nobel Prize for saying opposing things Price Determination: Interaction of Supply and Demand Objectives: 1. Examine interaction of supply and demand forces in determining market price 2. Describe concept of market structure 3. Illustrate price determination under perfect comp 4. Discuss length of run in agricultural price determination 5. Firm-level economics of perfect and imperfect comp 6. Discuss price discrimination Market structure State of a market with respect to competition. Market structure depends on such characteristics as: number of buyers and sellers (economists commonly assume many buyers and then differentiate mkts by the number of sellers) their size distribution degree of product differentiation ease of entry into market
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2 Chapter 3 Markets can be classified as: Perfect competition - many sellers of homogenous product (a number of agricultural products) Monopolistic competition - many sellers of similar, but differentiated product (magazines) Oligopoly – a few large firms selling –homogeneous products (pure oligopoly), e.g., aluminum differentiated products (differentiated oligopoly), e.g., breakfast cereal Monopoly - one seller of unique product Less competition How would you classify following markets? U.S. corn farmers New car market in Ithaca Higher education market Electric utilities Perfectly competitive market has following traits: 1. Large number of sellers (price takers) –each is so small in relation to the entire market that no buyer or seller can affect the product’s price 2. Homogenous product –the product of each seller is identical to that of others 3. No barriers to entry –all resources are completely mobile; it is costless for resources to enter or leave the market 4. Perfect information on prices and costs –all buyers and sellers have perfect knowledge of the relevant forces determining prices 5. No artificial restrictions on demand, supply, or prices Some industries satisfy most of the above assumptions. Eg. In NYSE, many people buy and sell shares of stocks of IBM. However, no market is perfectly competitive, some markets approximate competitive conditions, and are defined as purely competitive .
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3 Chapter 3 barriers to entry Source: Perloff 1994, Modern Industrial Organization Barriers to entry can include: advertising, customer loyalty, patents, and government regulations, etc. Price determination under perfect competition Seller’s objective: get highest price Buyer’s objective: get lowest price Collective interaction => equilibrium price Equilibrium price determined where quantity supplied equals quantity demanded Price Quantity Supply Demand P* Q* Market equilibrium
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4 Chapter 3 Equilibrium price is only stable price Why?
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CHAP3 - Price Determination: Interaction of Supply and...

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