In this class, we will derive equilibrium outcomes across a variety of market structures. We will begin by understanding equilibrium under a market structure called Perfect Competition, a benchmark construction. Economists have tools to measure the efficiency of market outcomes. We next consider the polar extreme of a competitive market: a monopoly market. We will determine the monopoly equilibrium price and quantity and efficiency properties. Much economic activity takes place in markets with just a handful of very large producers. To understand equilibrium in these oligopoly markets requires more careful attention to strategic interdependence. To capture this interdependence, we consider collusive arrangements among a small number of rivals as well as the use of simple game theoretic techniques to model equilibrium. Market Failure describes situations where markets fail to find the efficient outcome. Information asymmetries are one fertile form of market failure. Another form of market failure occurs when externalities are present. We will examine one key externality, pollution, and construct a policy prescription to mitigate the negative efficiency impacts of this externality. Upon successful completion of this course, you will be able to: • Explain how different market structures result in different resource allocations. • Model the impact of external shocks to a particular market structure and demonstrate the new equilibrium price and quantity after the impact of this external shock has played out. • Evaluate the efficiency of an equilibrium. Different market structures produce different levels of efficiency. • Explain when and why the government might intervene with regulatory authority or antitrust litigation to lessen inefficiencies in some markets. • Describe how information problems can cause inefficient outcomes. • Understand externalities and consider optimal government response to these market failures. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.
1-2.1. Build Short Run Equilibrium Framework
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From the course by University of Illinois at Urbana-Champaign
Firm Level Economics: Markets and Allocations
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University of Illinois at Urbana-Champaign
255 ratings
Course 2 of 7 in the Specialization Managerial Economics and Business Analysis
From the lesson
Module 1: Perfect Competition
This module introduces the concept of a perfectly competitive market. It is a benchmark construction, but it accurately models many markets in our economy. We will understand equilibrium outcomes in both the short run and the long run. We will understand how to analyze shocks to these equilibria.
Meet the Instructors
Larry DeBrockDean Emeritus and Professor of Finance and Professor of Economics
University of Illinois, Urbana-Champaign College of Business Department of Business Administration
[SOUND]
We're going to take what we understand about the individual firm supply curve.
We had constructed that supply curve by recognising that the individual
firm with its marginal cost curve,
we'll maximize profits by setting marginal revenue equals marginal cost.
Marginal revenue equals marginal cost.
And the marginal revenue is a curve that is essentially a horizontal line
at whatever the current market price is, coming from the market-generating process.
For example the board of trade sets the price of corn,
corn farmer will take that as the price and operate accordingly.
Now for a different possible prices I might call out,
the firm goes to where marginal equals marginal cost as long as we're at or
above our U shaped average variable cost curve.
And that means that we can construct a short run supply curve for the firm,
as that portional marginal cost group add above of the average variable cost.
That means I could construct the market supply is the aggregation.
So, think about it, suppose this is from what, there's a little supply curve for
firm one, but there's also a different supply curve for firm two and
it might be a little bit steeper.
It may have a different shape.
Why? Well,
maybe the land at this particular farm was a little bit less
suited to corn as the other one so supply curve is going to be a bit different.
All I need to know is that it reflects
the upward solving portion of the marginal cost curve.
It's going to be upward solving also.
And I've got a lot of these and what I want to do is add them all up for
the N firms in the industry.
Each of these firms is going to have their own little, and the sum of those
we'll put on an axis that has quantity on a horizontal, price on the vertical.
But notice I've got cap Q now.
And that will be the market supply curve.
So this is the sum of the marginal cross for
the N players in the industry.
That's going to be my market supply curve.
Now these graphs are a little bit small, a little bit shaky, but let's move
to something a little bit more detailed and a little bit clearer because we're
going to have to build something that economists call side by side analysis.
It's a rather elaborate picture.
But you see what it is?
On the left hand panel I've got the market output.
You know that, because that's the capital Q on horizontal axis, market output.
And there is our old friend the demand curve and there's the supply curve.
And now we recognizes,
that the supply curve is just equal to the sum of the marginal cost curves.
Over I equal one to N.
The N firms in the industry.
I'm adding all their marginal cost curves up and I have a moderate supply curve.
On the right hand panel you should note I've got lowercase Q here so
this is the individual firm.
There's a lot of these out there but I'll only need to show you one.
So the left handle panel is market, right hand panel individual firm.
Individual firm goes to where marginal revenue goes marginal cost.
That's going to be in equilibrium to this firm.
What we want to do is to figure out how changes in the market changes
the firms behavior.
We're now all ready.
We build the material that'll help us to figure this out.
I want to add one last curve to this picture.
I'm going to put the average cost curve on.
This is the average total cost, and I look at this picture,
and I say, well, you know what?
There's a lot of information captured in this picture.
There's a lot of information that will help me figure this industry out.
So, the first thing I want to remember is I know earlier we constructed
a rule that said that profit, for the firm.
And this is economic profit for
the firm, is equal to total revenue minus total cost.
But I know I can re-write that as price times quantity
minus average total cost times quantity.
And what that means is that I can factor out of here quantity
times the bracket price minus average total cost.
It shows us what the size of profit is.
The number of units you produce, that's Q,
times the per-unit markup, price minus average total cost.
That will give you your total profit for this operation.
Well, do we have this information?
Sure.
Take a look at this.
I know that this vertical gap right here
is equal to price minus average total cost.
It's a positive number because price is greater than average total cost.
I know this horizontal bar that's equal to output.
So if I multiply that horizontal bar by that vertical,
it's basically base time height, that gives me the area of this rectangle.
And the area of that rectangle is going to be our profit in this situation.
So, positive economic profit, that's a good world to be in.
Remember, positive economic profit means something really important to us.
Economic profit is different than accounting profit because economic
profit takes into consideration one of your costs is your next best alternative.
So, the fact that you're making positive economic profit, means,
that you're making more money than you would've in any other line of business.
It's a good deal, that's a nice place to be at this situation.
The question is, we need to talk about, is this an equilibrium, okay?
Are we in some point called equilibrium because
from the very beginning we've worried a lot about equilibrium.
Thinking a lot about this course, thinking about understanding economics as
an analyst, equilibrium is sort of our fall back comfort zone.
It tells us why people would go there.
And it sometimes tells us no, no that's not going to be an outcome Larry.
People are actually going to want to run like that,
from that, with their hair on fire.
So we have to think about, is this an equilibrium outcome.
And so the way we're going to think about this is I'm going to put a new
page up here, and I'm going to ask about equilibrium conditions.
Now I gotta make sure that I put it in blue,
going to make sure that we're talking about.
Everybody knows we're talking about the short run and
equilibrium is going to be pretty simple, I'm going to step back to that page.
Equilibrium means no tendency for change what we got two panels so
we going to ask both panels is there any reason to change?
So look at the left hand panel cap P sub zero, cap Q sub zero.
Is there any reason to move from there?
And the answer is no.
Supply is equal to demand.
That means the amount that people voluntarily want to put on the market
is exactly equal to the amount people voluntarily want to buy from the market
with their little, green sheets of paper.
And so, one of the conditions is what we'll call,
the market has to be in equilibrium.
And that means supply is equal to demand.
If supply is equal to demand, there's no reason for change in the market, so
that's part of our equilibrium.
But, let's go back, we also have to ask a question about the right hand panel.
The right hand panel says is there any reason for anyone to change here?
Well, the player we have is individual firm there's this lowercase Q,
and the firm is at Q sub zero.
The firm is operating where marginal revenue equals marginal cost, is that
where the firm, does the firm want to stay there, or does the firm want to move?
You know the answer to that.
Marginal revenue equals marginal cost.
If the firm has point where marginal revenue equals marginal cost,
it's maximizing profits.
There's no tenancy to change there.
Let's say well maybe they don't want to produce at all, Larry.
No. They're making positive profits.
They got a big smile on their face, they're making more than they could if
they were elsewhere, and they're making the most they possibly can.
And so, the second condition is, we need the firm to be in equilibrium.
And, the condition really is that.
We want marginal revenue to be equal to marginal cost and
then I'm going to put parenthetically at or above
average variable cost because we know that if in fact, marginal revenue is marginal
cost is some level below average variable cost, this firm's going to shut down.
That means they're going to produce zero.
There's not going to be any production from that.
And they're just going to sit by their phone waiting for the broker to call to
get them out in the long run, because they're just losing too much money.
That's not the case in this particular example I showed you.
This case, the firm,
because I drew that curve there they are making positive profits, they're
maximizing the best they possibly can so this is indeed a short run equilibrium.
Two questions, yes and yes means we found a short run equilibrium.
Now, the next thing is we need to move this into the long run.
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