ajaz_eco_204_2012_2013_chapter_15_Competition

As we argued in consumer theory for kodak to have

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Unformatted text preview: ange preferences back and Kodak has no choice but to lower its price. As we argued in consumer theory, for Kodak to have market traction while avoiding a price war it would have to choose a new price such that: Kodak needs to charge a slightly lower price than Fuji because it has a lower quality than Fuji. Price rivalry due to large numbers arising from no or low barriers to entry: From 1938 – 1978, the airline industry was regulated by the government which capped fares and restricted entry. In 1979, the U.S. airline industry was deregulated, and almost immediately was flooded by a wave of new entrants, triggering price rivalry, and lowering fares: U.S. Airline Industry: Average Fare and Number of Carriers from 1979 – 2010 Year Average Fare (in constant 2000 dollars) Number of Carriers 1979 441.69 36 1980 467.14 64 1985 391.97 102 1990 378.94 96 1995 313.40 96 1996 312.23 96 1997 309.17 96 1998 316.20 96 1999 308.51 94 2000 314.46 91 2001 283.04 87 2002 261.21 83 2003 258.65 72 2004 244.97 80 2005 241.82 85 2006 255.38 87 2007 247.56 87 2008 255.30 88 2009 230.80 76 2010 249.76 77 Sources: Own calculations compiled from Airlines.org Annual Round-Trip Fares and Fees: Domestic, RITA @ Bureau of Transportation Statistics, and US Department of Commerce, US Statistical Abstracts. While competition is defined as “price taking behavior” and not “large number of sellers”, one can argue in this case that the “large” number of carriers has given rise to price taking behavior, a process facilitated by the fact that air travel is for all practical purposes a “homogeneous good” so that price is most important dimension in which carriers compete with each other. 3 ECO 204 Chapter 15: Competitive Firms and Markets (this version 2012-2013) University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. From ECO 100 recall that in perfect competition, the price is determined as the market clearing price at which the market is in “equilibrium”, i.e. where total quantity demanded equals total quantity supplied: Sum of individual firms’ supply curves. Market Supply Curve Price taking consumers Price taking firms Market Demand Curve Sum of individual agents’ demand curves. In the rest of this chapter we will: Derive the market (aggregate) demand curve from individual consumers’ demand curves, which in turn are derived from each individual consumer’s Utility Maximization Problem (UMP). Derive the market (aggregate) supply curve from individual firms’ supply curves which in turn, as we will see, are derived from each individual firm’s Cost Minimization Problem (CMP). Derive the equilibrium market price and quantity. Analyze a real life business case and derive a “real life” supply model which can be used to trade commodities. Throughout this chapter we will almost always analyze competitive firms in the short run. 2. The Competitive Market: Market Demand Curve Consider a “good” (product/service) sold in a competitive market with price taking firms, where “price taking” behavior may arise with a “few” firms. Start by assuming that the “market” consists of “price taking” rational consumers with exogenously given incomes2. In ECO 204 we assumed that a rational consumer’s preferences can be modeled by a continuous, though not necessarily differentiable, utility function. Given prices and income, each consumer is assumed to have solved her UMP and derived her individual demand function for this good sold in the competitive market. Let: Given price Given price quantity demanded by an individual price taking consumer this is total “market” quantity demanded by all consumers in the market ∑ 2 Note to self: starting with 204 summer 2013, differentiate between partial and equilibrium models and introduce the already written chapter on buyers and sellers. 4 ECO 204 Chapter 15: Competitive Firms and Markets (this version 2012-2013) University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. Since ∑ we can derive the market demand function as the sum of individual demand functions, and from this derive the market demand curve. Let’s do some examples: __________________________________________________________________________________________________ Example: Suppose “good 1” is the commodity being analyzed and “Good 2” is “all other goods”. Suppose there are consumers (A, B, C) with identical Cobb-Douglas utility functions, and individual-specific incomes respectively. We can solve each consumer’s UMP (do it!) and derive their individual demand functions for good 1 (remember that in consumer theory we assumed that consumers were price takers): From this we can derive the market demand function for good as: ∑ (⏟ ) ∑ ∑ This expression is as if we had solved a Cobb-Douglas UMP for a consumer with the utility function and income level ∑ . That is, three consumers’ total demand for good 1 is as if these three consumers behave as one single price taking “repre...
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This document was uploaded on 01/19/2014.

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