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					           Demand analysis
• Firms sell goods/services to buyers
  – Consumers (individuals) : utility
  – Firms : make profits
• Willingness to pay: maximum price buyer
  will pay for a good
  – Point of indifference between buying and not
  – Lower price always preferred by buyer
• Willingness to pay is determined by
  – Buyer’s tastes or needs
  – Income and wealth
     • Normal/inferior goods
     • Cyclical/acyclical demand
  – Substitutes
  – Complementary goods
• Demand curve for an
  individual buyer
   – Willingness to pay for
     different quantities of the
   – Or, quantity demanded at
     each price
   – Usually downward sloping:
     lower willingness to pay for
     additional units
       • Lower utility of
         consumption for
       • Lower productivity of
         resources for firms
• Shifts in demand curve
• Market demand
  –   Sum of individual demand curves
  –   Aggregate quantity demanded at each price
  –   Arrays individual buyers in order of willingness to pay
  –   Identical goods? Product differentiation?
• Market segments / Price discrimination
  – Different segments willing to pay different
  – Consumer surplus
  – Can firms exploit this?
     • Feasible?
     • Fair?
• Price sensitivity of demand
  – Slope of market demand curve
  – Flat demand curve: very price sensitive: Elastic
     • Goods with good substitutes
     • Luxury items ?
  – Steep demand curve: less sensitive: Inelastic
     • Necessities
• Time-frame: easier to
  find substitutes over
  long run
• Demand curves
  – Accept as given?
  – Seek to modify?
            Supply analysis
• Supply curve
  – How much the firm will sell at each price
  – Assumption: price-taking firm
• Time-frame of supply decision
  – Long run: compete in the market at all?
  – Short run: how much to produce & sell?
• Short run supply
• Based on costs
  – Fixed costs: incurred regardless of volume
     • ‘headquarter’ costs, depreciation, rent, labor….
  – Variable or marginal costs: cost per additional unit
     • Raw materials, electricity, labor….
• In the short run, fixed costs are inevitable
• Should not affect short run supply decisions (?)
• Marginal costs
  – Cash costs: out-of-
  – Opportunity costs:
    foregone profits
• Marginal cost curve :
  Short run supply
• Long run supply: entry & exit
• Recover both fixed and variable costs
• Fixed costs
  – Out-of-pocket costs
  – Opportunity costs: return on capital
• Average costs
  – Includes both fixed
    and variable costs
  – Typical U shape
  – Minimum of the
    average cost curve:
    Optimal long run
    supply point
  – Market price must
    exceed price at this
  – Determine entry and
  – Dynamics?
• Shifts in supply curve
  – Input costs
  – Technology
• Market supply curve
  – Sum of individual supply curves
  – Usually slopes upward
     • Less efficient firms enter market when price is high
     • Arrays firms from most efficient to least
• Supply elasticity
  – Flat supply curve: very sensitive to price:
  – Steep supply curve: less sensitive: Inelastic
• Varies over the range of output
  – Elastic when spare capacity is available
  – Inelastic when capacity constrained
Market equilibrium
         • Interesection of market
           demand and supply
         • Disequilibrium will cause
           price to adjust and yield
           new equilibrium
         • Real world: series of
           small disequilibriums,
           series of price
         • Currency markets: rapid,
           continuous adjustments
• Profit calculation
  based on equilibrium
• Average and marginal
• Marginal cost
  determines supply
• Average costs at that
            Market adjustment
• Shifts in demand and supply curves
  – Increase: shift to the right
  – Decrease: shift to the left
• Impact on quantity and price
• Inelastic curves: adjustment largely through
• Elastic curves: adjustment largely through
• Short run versus long run
           Perfect competition
•   Three assumptions:
    1. Identical products
    2. Many small price-taking buyers and sellers
    3. Full information
•   Excess profits  more firms enter 
    increased supply  lower price  zero
    excess profits
•   Three more conditions:
    1. Identical sellers
    2. Free entry
    3. Free exit
•   Zero excess profits
•   Long run profitability?
  Departures from perfect competition

• Most markets have far from perfect competition
   – Exceptions: commodities
• Secret of long run profitability: deviations from
  perfect competition
• Few sellers or buyers
   – Extreme case: monopoly or monopsony
   – Oligopoly
      • Collusion
      • Cartels: incentives to cheat the cartel
   – Societal impact: anti-trust regulation
• Entry and exit barriers
  – First mover advantage
     • Headstart on learning curve
     • Economies of scale
     • Reputation and branding
  – High exit costs
     • May lead to firms accepting sustained losses
• Product differentiation
  – Special attributes: Real or imaginary
• Differences among
  – Least cost producer
  – Innovation
• Imperfect information
  – Search costs protect
    existing relations and