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Chapter 8 (2) - Coggle Diagram
Chapter 8 (2)
Unit 8
Buyers must force each other to be price takers:
- There must be many buyers, competing with each other
A market with all of these properties is described as perfectly competitive. We can predict that the equilibrium in such a market will be a competitive equilibrium so it will have the following characteristics:
- All transactions take place at a single price this is known as the law of price
- At that price the amount supplied equals the amount demanded: the market clears
- No buyer or seller can benefit by altering the price they are demanding or offering. They are all price takers
- All potential gains from trade are realized
To generate competition between sellers and force sellers to act as price takers, we need:
- Many undifferentiated sellers
- Sellers must act independently
- Many buyers all wanting to buy the good
- Buyers know the sellers' prices
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The model of supply and demand can be a useful approximation to help us to understand how some markets for non-identical products behave
The market for an imaginary product called Choccos for which there are close substitutes, as many similar products compete in the wider market for chocolate bars. Due to competition from other chocolate bars, the demand curve is almost flat. The range of feasible prices for Choccos is narrow, and the firm chooses a price and quantity where the marginal cost is close to the price. So this firm is in a similar situation to a firm in a perfectly competitive market. It is the equilibrium price in the larger market for chocolate bars that determines the feasible prices for Choccos - they have to be sold at a similar price to other chocolate bars. The narrow range of feasible prices for this firm is determined by the behaviour of its competitors. So the main influence on the price of Choccos is not the firm, but the market for chocolate bars as a whole
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Unit 9
Perfect competition requires that consumers are sufficiently sensitive to prices to force firms to compete and this may not be the case in any market where consumers have to search for products. If it takes time and effort to check prices and inspect products, they may decide to buy as soon as they find something suitable rather than continue the search for the cheapest
Perfect competition uses two tests:
- Do all trades take place at the same price?
- Are firms selling goods at a price equal to marginal cost?
Unit 10
In the supply and demand model firms are price takers. Competition from other firms producing identical products means that they have no power to set their own prices. This model can be useful as an approximate description of a market in which there are many firms selling very similar products even if the idealized conditions for a perfectly competitive market do not hold
Advertising in a competitive market is a public good: the benefits go to all of the firms in the industry
The model also applies to a firm producing differentiated products that are similar but not identical to those of its competitors. The firm still has the power to set its own price but if it has close competitors demand will be quite elastic and the range of feasible prices will be narrow
The same is true of expenditures to influence public policy: if a large firm with market power is successful then it will benefit directly.
The firm produces a product that is different from the products of other firms giving it market power to set its own price, a monopolist
One way that successful large firms can emerge is by breaking away from the competition and innovating with a new product
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Unit 11
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A market is in competitive equilibrium if all buyers and sellers are price takers and at the prevailing market price, the quantity supplied is equal to the quantity demanded (the market clears)
The model of perfect competition describes a set of idealized market conditions in which we would expect a competitive equilibrium to occur
Buyers or sellers who have little influence on market prices due to competition are called price takers
Unit 6
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The equilibrium price is $8 and 24 books are sold, as shown by point A.
In the market for second hand textbooks, demand comes from new students enrolling on the course, and supply comes from students who took the course in the previous year
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The steeper (more inelastic) the supply curve, the higher the price will rise and the lower the quantity will increase. If the supply curve is quite flat (elastic) then the price rise will be smaller and the quantity sold will be more responsive to the demand shock
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At the new equilibrium both price and quantity are higher. Although demand has increased not all the students who would have bought at $8 will purchase the book at the new equilibrium: those with WTP between $8 and $10 no longer want to buy
Suppose that bakeries discover a new technique that allows each worker to make bread more quickly. This will lead to a fall in the marginal cost of a loaf at each level of output. In other words, the marginal cost curve of each bakery shifts down
Increase in demand:
- Demand is higher at each possible price, so the demand curve has shifted
- In response to this shift there is a change in the price
- This leads to an increase in the quantity supplied
- This change is a movement along the supply curve
- But the supply curve itself has not shifted so we do not call this an increase in supply
Another reason for a change in market supply is the entry of more firms or the exit of existing firms. There were 50 bakeries in the city. The equilibrium price of $2 each bakery is on an isoprofit curve above the average cost curve. If economic profits are greater than zero, firms are receiving an economic rent, so other firms might want to invest in the baking business
Shifts in supply and demand are often referred to as shocks in economic analysis. The shock is called exogenous because our model doesn't explain why it happened: the model shows the consequences, not the causes
The improvement in the technology of bread-making leads to:
- an increase in supply
- a fall in the price of bread
- a rise in the quantity sold
When the MC curve of each bakery shifts down, so does the market supply curve for bread.
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We find the market supply curve by adding up the amounts of bread supplied by each firm at each price. When more bakeries have entered more bread will be supplied at each price level. A fall in price and a rise in bread sales
New bakeries may decide to enter the market, there will be some costs of entry, acquiring and equipping the premises
The entry of new firms shifts the supply curve outwards. There is more bread for sale at each price, so at the original price there would be excess supply. The new equilibrium is at point B with a lower price and higher bread sales. The market price has fallen to $1.75 so they must be making less profit than before
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Unit 7
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Initially the market equilibrium is at point A: the price is P and the quantity of salt traded is Q. Suppose that a sales tax of 30% is imposed on the price of salt, to be paid to the government by the suppliers. If suppliers have to pay a 30% tax, their marginal cost of supplying each unit of salt increases by 30%. So the supply curve shifts: the price is 30% higher at each quantity. The new equilibrium is at point B where a lower quantity of salt is traded. Although the consumer price has risen, note that it is not 30% higher than before. The price paid by consumers P1 is 30% higher than the price received by the suppliers which is P0. Suppliers receive a lower price than before they produce less and their profits will be lower
Take the taxation of salt. Salt was used all over the world as a preservative allowing food to be stored, transported and traded
Although the suppliers pay the tax, the tax incidence falls partly on consumers and partly on producers
Governments can use taxation to raise revenue or to affect the allocation of goods and services in other ways, perhaps because the government considers a particular good to be harmful
The effect of the tax on consumer and producer surplus:
- Consumer surplus falls: Consumers pay a higher price and buy less salt
- Producer surplus falls: They produce less and receive a lower net price
- Total surplus is lower: even taking account of the tax revenue received by the government, the tax causes a deadweitght loss
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In general taxes change prices, and prices change buyers' and sellers' decisions , which can cause deadweight loss. To raise as much revenue as possible, the government would prefer to tax a good for which demand is not very responsive to price, so that the fall in quantity traded is quite small, a good with a low elasticity of demand
Since the quantity of salt traded is no longer at the level that maximizes gains from trade, the tax has led to a deadweight loss
When the salt tax is imposed, the total surplus from trade in the salt market is given by:
total surplus = consumer surplus + producer surplus + government revenue
The overall effect of the tax depends on what the government does with the revenues that it collects:
- The government spends the revenue on goods and services that enhance the wellbeing of the population: Then the tax and resulting expenditure may enhance public welfare even though it reduces the surplus in the particular market that is taxed
- The government spends the revenues on an activity that does not contribute to wellbeing: Then the lost consumer surplus is just a reduction in the living standards of the population
We have drawn the supply curve for butter as almost flat, on the assumption that the marginal cost of butter for retailers does not change very much as quantity varies. The initial equilibrium is at point A where the price of butter is 45 kr per kg, and each person consumes 2kg of butter per year. A tax of 10kr per kg shifts the supply curve upwards and leads to a rise in price to 54 kr and a fall in consumption to 1.6kg and the consumer price rises by 9 kr. and the suppliers net revenue per kg of butter falls to 44 kr. The tax incidence is felt mainly by consumers. The price received by the retailers is only 1 kr lower
Taxing a good whose demand is inelastic is an efficient way to transfer the surplus from consumers to the government
Policymakers in many countries are interested in the idea of using taxes to deter consumption of unhealthy foods with the objective of improving public health and tackling the obesity epidemic
The level of the Danish tax was 16 Danish kroner (kr) per kilogram of saturated fat, corresponding to 10.4 kr per kg of butter. The Danish fat tax, corresponded to about 22% of the average butter price in the year before the tax. This study found that it reduced the consumption of butter and related products by between 15% and 20%
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Any taxation system requires effective mechanisms for tax collection, and designing taxes that are simple to administer is an important goal of tax policy
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Both consumer and producer surpluses fall. The area of the green rectangle represents the tax revenue, with a tax of 10 kr per kg and equilibrium sales of 1.6 kg per person tax revenue is 10 x 16 = 16 kr per person per year
Some important implications of the tax:
- Consumption of butter products fell: in this case by 20%. In this respect the policy was successful
- There was a large fall in surplus especially consumer surplus, the governments aim when it implemented the fat tax policy was not to raise revenue, but rather to reduce quantity. So the fall in consumer surplus was inevitable. The loss of surplus caused by a tax is a deadweight loss, which sounds negative. The policymaker might see it as a gain if the good, butter, is considered bad for consumers