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
284 ratings
University of Illinois at Urbana-Champaign
284 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
We're going to take what we understand about the individual firm supply curve.
We had constructed that supply curve by recognizing that
the individual firm with
its marginal cost curve will maximize
profits by setting marginal revenue equals marginal costs.
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, a Board of Trade sets the price of corn and
corn farmer would take that as the price and operate accordingly.
Now, for different possible prices I might call out,
the firm goes to where marginal revenue 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 portion of the marginal cost curve,
at or above the average variable cost.
Now, that means I can construct the market supply as the aggregation.
So, think about it.
Suppose this is firm one.
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 farmer is a little bit
less suited to corn than the other one so
the supply curve is going to be a little bit different.
All I need to know is that since it
reflects the upward sloping portion of the marginal cost curve,
it's going to be upward sloping also,
ad 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 there.
Each of these firms is going to have their own little and some of
those we'll put on axis that's got quantity on the horizontal axis.
Price is 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 cost 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'll see what it is.
On the left-hand panel,
I've got the market output.
You know that because it's the capital Q on the horizontal axis,
market output, and there is our old friend,
the demand curve, and and there's the supply curve.
Now, we recognize that that supply curve is just equal to
the sum of the marginal cost curves over I equals one to N,
the N firms in the industry.
I'm adding all their marginal cost curves up and I have a market supply curve.
On the right-hand panel,
you should note I've got q here.
So, this is the individual firm.
There's a lot of these out there, but I'm just going to only need to show you one.
So, the left-hand panel is market,
the right-hand panel, individual firm.
Individual firm goes to where marginal revenue equals marginal cost.
That's going to be an equilibrium for this firm.
What we want to do is to figure out how
this changes in the market changes the firm's behavior.
We built 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 rewrite 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 times 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.
Because 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 cost as 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 about this course,
thinking about understanding economics as an analyst,
the equilibrium is sort of our fallback 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. People are actually going to
run from that with their hair on fire."
So, we have to think about is this an equilibrium outcome?
So, the way we're going to think about this.
So, I'm going to put a new page up here and I'm going
to ask about equilibrium conditions.
I've got to make sure and I'll put it in blue.
I'm going to make sure we're talking about,
everybody knows we're talking about the short run.
Equilibrium is going to be pretty simple.
I'm going to step back to that page.
Equilibrium means no tendency for change. Well, we've got two panels.
So we're going to ask both panels: Is there any reason to change?
So, look at the left-hand panel.
Cap P subzero, cap Q subzero.
Is there any reason to move from there?
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.
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.
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 anybody to change here?"
Well, the player we have is individual firm.
There's this q and the firm is at Q subzero.
The firm is operating where marginal revenue equals marginal cost.
Is that where the firm wants to move from?
Does the firm want to stay there or does it want to move?
You know the answer to that, marginal revenue equals marginal cost.
If the firm is found the point
where marginal revenue equals marginal cost, it's maximizing profits.
There's no tendency to change there.
Say," Well, maybe they don't want to produce at all."
No, they're making positive profits.
They've 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.
So, the second condition is we need the firm to be in equilibrium.
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 equals marginal cost,
at some level below average variable cost,
this firm is 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 the 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've showed you.
In this case, the firm,
because I drew that curve there,
they're making positive profits,
they're maximizing and doing the best they possibly can.
So, this is indeed a short-run equilibrium. Two questions?
Yes and yes.
It 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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