A.2 Competitive Equilibrium
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Readings Baye 6th edition or 7th edition, Chapter 2
BA 445 Lesson A.2 Competitive Equilibrium
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Overview
Overview
BA 445 Lesson A.2 Competitive Equilibrium
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Overview Substitutes and Complements describe goods that either clash or match. — So, they explain the affect of higher-priced Coke on the demand for Pepsi, but not higher-priced housing on the demand for cars. Comparative Statics determines how competitive equilibrium price and quantity react to a change in a determinant of demand or supply. — So, how is customer service affected by increasing US wages? Price Restrictions impose either maximum or minimum legal prices. Unintended consequences include shortages and surpluses, and contrary full economic prices when demanders or suppliers compete.
BA 445 Lesson A.2 Competitive Equilibrium
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Substitutes and Complements
Substitutes and Complements
BA 445 Lesson A.2 Competitive Equilibrium
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Substitutes and Complements
Overview
Substitutes and Complements describe goods that either clash or match. — So, they explain the affect of higherpriced Coke on the demand for Pepsi, but not higher-priced housing on the demand for cars.
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Substitutes and Complements
Simplified Definition • A common definition is Good X and Good Y are • •
substitutes if an increase in price of X increases demand for Y complements if an increase in price of X decreases demand for Y
• There are examples when that definition makes sense: •
Apples and oranges: An increase in price of apples increases demand for oranges because consumers substitute one fruit for the expensive fruit.
• But in some other examples that definition makes no sense: •
•
Pepperdine and oranges: An increase in tuition at Pepperdine decreases demand for oranges but not because Pepperdine and oranges are complements. (Rather, consumers can no longer afford fruit.) Pepperdine and Raman noodles: An increase in tuition at Pepperdine increases demand for noodles but not because Pepperdine and noodles are substitutes. (Rather, consumers can no longer afford other food.) BA 445 Lesson A.2 Competitive Equilibrium
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Substitutes and Complements
• A later lesson extends the definition of substitutes and complements to gross substitutes and gross complements.
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Comparative Statics
Comparative Statics
BA 445 Lesson A.2 Competitive Equilibrium
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Comparative Statics
Overview
Comparative Statics determines how competitive equilibrium price and quantity react to a change in a determinant of demand or supply. — So, how is customer service affected by increasing US wages?
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Comparative Statics
Comparative Statics Question • How do the equilibrium price and quantity change when a determinant of supply and/or demand changes? Example: The Wall Street Journal reports that the prices of PC components are expected to fall by 2 to 4 percent over the next six months. • Scenario 1: You manage a small firm that makes PCs. • Scenario 2: You manage a small software company.
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Comparative Statics
Scenario 1: Implications for a Small PC Maker • Step 1: Identify which goods are affected. • Step 2: Draw and analyze Demand and Supply graphs. • Step 3: Organize an action plan (worry about details).
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Comparative Statics
Big Picture: Impact of decline in component (normal input) prices on PC market S Price of S* PCs P0 P*
D
Q0
Q*
Quantity of PCs
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Comparative Statics
Analysis • Equilibrium price of PCs will fall, and equilibrium quantity of PCs will increase. Action plan (plan ahead because actions take time) • Input suppliers? Tell them you’ll increase your orders (for normal inputs). • Human resources? Start a job search and training now for employment to start after component prices fall, assuming labor is a normal input. • Marketing? Plan marketing for increased sales after component prices fall. • Get quantitative estimates of the qualitative effects above (not covered in this chapter).
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Comparative Statics
Scenario 2: Implications for a Software Maker • More complicated chain of demand and supply graphs. • Step 1: Use Scenario 1 analysis to deduce that lower component prices will lead to
a lower equilibrium price for personal computers. a greater number of personal computers sold.
• Step 2: How will those changes affect the demand and supply graph in the software market?
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Comparative Statics
Big Picture: Impact of lower PC prices on the software (gross complement) market S Price of Software
P1 P0 D* D
Q0 Q1
Quantity of Software
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Comparative Statics
Analysis • Equilibrium price of software will increase, and equilibrium quantity of software sold will increase. Action plan (like the plan for PC makers) • Input suppliers? Order more distribution disks. • Human resources? Start a job search and training now for employment of distribution people to start after demand increases. • Marketing? Plan marketing for increased sales. • Get quantitative estimates of the qualitative effects above (not covered in this chapter).
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Price Restrictions
Price Restrictions
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Overview
Price Restrictions impose either maximum or minimum legal prices. Unintended consequences include shortages and surpluses, and contrary full economic prices when demanders or suppliers compete.
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Price Restrictions
Price Restrictions • Price Ceilings Set a maximum legal price that can be charged. Some examples • Affordable health care. • Housing in New York City. • Gasoline just after OPEC.
• Price Floors Set a minimum legal price that can be charged. Some examples • Minimum wage. • Agricultural price support. BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Effect of a price ceiling on health care is an immediate shortage since demand increases and supply decreases. In the graph, as price decreases from the equilibrium P to the maximum Pm, Demand increases from Q to B Supply decreases from Q to A The smaller quantity (A) will be exchanged. B-A is a shortage.
Price
Qs
P Pm
Qd Quantity A
Q
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Competition among demanders to be the ones to buy some of the limited supply eliminates that shortage by adding a non-pecuniary (non-money) price that demanders pay. In the graph, to buy the good, demanders pay price pm plus a nonpecuniary price (like the cost of waiting in line), making the total price Pf, At Pf, demand is reduced to A Demanders pay Pf Suppliers receive Pm Pf - Pm is the nonpecuniary price.
Price
Qs
Pf P Pm
Qd Quantity A
Q
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Price Restrictions
Full Economic Price is the dollar amount paid to a supplier under a price ceiling plus the non-pecuniary (nonmoney) price demanders pay through their competition to buy.
Ironically, the full economic price Pf is greater than the price P if there were no price ceiling.
Price
Qs
Pf P Pm
Qd Quantity A
Q
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Nonpecuniary cost of health care Canada has a price ceiling on health care • The nonpecuiary cost is patients waiting:
Wait times are nearly a year for knee replacement surgery. Six months for hip replacements. Three months for brain, prostate and breast cancer surgeries.
• One prediction not covered in the supply-and-demand analysis is that some patients die while waiting for surgery. • Another prediction not covered is the quality of care is lower.
Canadians do not get many advanced medical treatments and use of technologies that are common to Americans.
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Price Restrictions
Nonpecuniary cost of New York City Apartments New York City has price ceilings on some apartments • The nonpecuiary cost is waiting or paying an agent
Apartment seekers in NYC often require the services of a real estate agent or apartment broker to assist them in securing an apartment lease. Typical broker fees are one month's rent.
• One prediction not covered in the supply-and-demand analysis is the quality of apartments is lower.
Rent controlled apartments receive lower maintenance and repair.
• Our supply-and-demand analysis considers only unsupported price controls, meaning the government does not increase supply.
Housing price support includes building low-cost housing. BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Nonpecuniary cost of Gasoline just after OPEC The U.S. had a price ceiling on gasoline in 1973 after OPEC reduced the supply of oil to increase price. • The non-pecuiary cost is waiting at the station. The cost includes both time and burning gas in line.
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Price Restrictions
Effect of a price floor on wages is an immediate surplus (unemployment) since demand decreases and supply increases. In the graph, as price (wage) increases from the equilibrium P to the minimum Pm, Demand decreases from Q to A Supply increases from Q to B The smaller quantity (A) will be exchanged. B-A is a surplus (unemployment).
Price
Qs
Pm P Qd Quantity A
Q
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Part of that demand decrease is outsourcing jobs to cheaper foreign labor, and part is replacing humans with machines.
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Price Restrictions
Competition among suppliers (workers) to be the ones to sell to meet some of the limited demand eliminates that surplus by subtracting a non-pecuniary (non-money) price from what suppliers receive. In the graph, to sell the good, sellers receive price pm minus a nonpecuniary price (like the cost of waiting in line), making the total price Pf, At Pf, supply is reduced to A Demanders pay Pm Suppliers receive Pf Pm - Pf is the nonpecuniary price.
Price
Qs
Pm P Qd
Pf
Quantity A
Q
BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Full Economic Price is the dollar amount paid by a demander under a price floor minus the non-pecuniary (non-money) price suppliers pay through their competition to sell.
Ironically, the full economic price Pf is lower than the price P if there were no price floor.
Price
Qs
Pm P Qd
Pf
Quantity A
Q
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Price Restrictions
Nonpecuniary cost of minimum wages The U.S. has a federal minimum wage and some states (intending to be sensitive to the poor) have higher minimum wages. The non-pecuniary cost to getting a minimum wage job includes
Dressing well, being agreeable or attractive to your boss, being bilingual, being on honors student. Showing up early and staying late, off the clock. Working at a faster rate.
• One prediction not covered in the supply-and-demand analysis is the environment of the job is lower.
More unsafe. Less comfortable. BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Example: Fast-food workers protest for higher wages in Los Angeles http://faculty.pepperdine.edu/jburke2/ba445/PowerP1/MiniWage.pdf
The article above describes fast-food protests that started in New York spread to Los Angeles and other cities across the nation Thursday as workers called for higher wages and the chance to unionize. In one case, dozens of fastfood workers and supporters marched outside a South Los Angeles Burger King at 6 a.m., chanting their demand for a $15-an-hour minimum wage.
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Price Restrictions
Analysis “One worker who planned to protest told KTLA-TV early Thursday morning that it’s unfair that some of his colleagues have been in the industry for more than 20 years and they still earn 8 bucks an hour. They have a family to feed and everything….They have two, three jobs and things just shouldn’t be like that, he said.” 1. Having a family (spouse, children) is a choice an individual makes to make himself better off. It does not make one more needy. 2. No matter how needy are workers, increasing minimum wages hurts them (makes them more needy) because of competition for jobs. BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Analysis “Industry groups such as the International Franchise Association said protesters' goals are unrealistic. Individual franchisees, not the bigwigs at corporate headquarters, determine wage levels for workers, according to the group. And many such operators are contending with thin margins made worse by a lagging economy, high commodity costs and soaring energy costs, according to the group.” 1. A lagging economy should increase (not decrease) demand for fast food, since it is an inferior good, and so increase demand (and wages) for fast-food workers. 2. Higher input costs decrease the supply of fast food, which in turn decreases demand for fast-food workers. BA 445 Lesson A.2 Competitive Equilibrium
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Price Restrictions
Analysis “Mandating increased wages would lead to higher prices for consumers, lower foot traffic and sales for franchise owners, and ultimately, lost jobs and opportunities for employees to become managers or franchise owners, …”
1. Mandating increased wages decreases the supply of fast food, which leads to higher prices for consumers and lower sales. 2. Mandating increased wages leads to lost jobs.
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Review Questions
Review Questions You should try to answer some of the review questions (see the online syllabus) before the next class. You will not turn in your answers, but students may request to discuss their answers to begin the next class. Your upcoming Exam 1 and cumulative Final Exam will contain some similar questions, so you should eventually consider every review question before taking your exams.
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BA 445
Managerial Economics
End of Lesson A.2
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