Question

3. (4 points) Perfect competition and equilibrium.

a. (1 point) Put the demand and supply curves together (at the original productivity and wages). Taylor assumes that she is in a perfectly competitive market. How many slices will she sell? At what price?

b. (1 point) Draw the graph again and shade in the entire area of consumer surplus. Shade in the entire area of producer surplus.

c. (2 points) Calculate consumer surplus as the sum of the difference between the marginal utility and the price for each slice up to the last slice sold. Calculate producer surplus as the sum of the difference between price and marginal cost for each slice.

Slices Workers 0.2 0.3 0.45 0.675 1.0125 MU Carrot Cake slices 11 $36.00 $32.40 $29.16 4 $26.24 $23.62 $21.26 $19.13 $17.22 $15.50 $13.95 $12.55 12 S11.30 $10.17 $9.15 0 000 von WN 1.51875 2.278125 3.4171875 5.12578125 7.688671875 11.53300781 17.29951172 25.94926758 38.92390137 Workers are paid S17/hour.

Answer 1

Perfect competition describes a market structure where competition is at its greatest possible level. To make it more clear, a market which exhibits the following characteristics in its structure is said to show perfect competition:

Characteristics of perfect competition market structure

A perfectly competitive market has the following characteristics:

a) There are many buyers and sellers in the market.

b) Each company makes a similar product.

c) Buyers and sellers have access to perfect information about price.

d) There are no transaction costs.

e) There are no barriers to entry into or exit from the market.

Equilibrium is defined as a state of balance or a stable situation where opposing forces cancel each other out and where no changes are occurring. An example of equilibrium is in economics when supply and demand are equal. An example of equilibrium is when you are calm and steady.

There are three types of equilibrium: stable, unstable, and neutral.

a) A demand curve shows the relationship between quantity demanded and price in a given market on a graph. The law of demand states that a higher price typically leads to a lower quantity demanded. A supply schedule is a table that shows the quantity supplied at different prices in the market.

The four basic laws of supply and demand are: If demand increases and supply remains unchanged, then it leads to higher equilibrium price and quantity. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and quantity.

In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, in a competitive market, the unit price for a particular good, or other traded item such as labor or liquid financial assets, will vary until it settles at a point where the quantity demanded (at the current price) will equal the quantity supplied (at the current price), resulting in an economic equilibrium for price and quantity transacted.

Although it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the goods, the standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the horizontal axis.

Since determinants of supply and demand other than the price of the goods in question are not explicitly represented in the supply-demand diagram, changes in the values of these variables are represented by moving the supply and demand curves (often described as "shifts" in the curves). By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves.

Supply schedule[edit]

A supply schedule, depicted graphically as a supply curve, is a table that shows the relationship between the price of a good and the quantity supplied by producers. Under the assumption of perfect competition, supply is determined by marginal cost: firms will produce additional output as long as the cost of producing an extra unit is less than the market price they receive.

A hike in the cost of raw goods would decrease supply, shifting the supply curve up, while a production cost discount would increase supply, shifting costs down and hurting producers as producer surplus decreases.

By its very nature, the concept of a supply curve assumes that firms are perfect competitors, having no influence over the market price. This is because each point on the supply curve answers the question, "If this firm is faced with this potential price, how much output will it be willing and able to sell?" If a firm has market power--in violation of the perfect competitor model--its decision on how much output to bring to market influences the market price. Thus the firm is not "faced with" any given price, and the relevant model must become more complex.

Economists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is the sum of the quantities supplied by all suppliers at each potential price: individual firms' supply curves are added horizontally to obtain the market supply curve.

Economists also distinguish between the short-run and the long-run market supply curves. Here short run means a constant availability of one or more fixed inputs (typically physical capital), and a fixed number of firms in the industry. In the long run, firms have a chance to adjust their producing capital, enabling them to better adjust the quantity they supply at any given price. Furthermore, in the long run competitors can enter or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are generally flatter than their short-run counterparts.

The determinants of supply are:

1. Production costs: how much a good costs to be produced. Production costs are the cost of the inputs; primarily labor, capital, energy and materials. They depend on the technology used in production, and/or technological advances. See Productivity.
2. Firms' expectations about future prices
3. Number of suppliers .

CONSUMER SURPLUS

Consumer surplus is the difference between the maximum price a consumer is willing to pay and the actual price they do pay. If a consumer is willing to pay more for a unit of a good than the current asking price, they are getting more benefit from the purchased product than they would if the price was their maximum willingness to pay.They are receiving the same benefit, the obtainment of the good, with a smaller cost as they are spending less than they would if they were charged their maximum willingness to pay. An example of a good with generally high consumer surplus is drinking water. People would pay very high prices for drinking water, as they need it to survive. The difference in the price that they would pay, if they had to, and the amount that they pay now is their consumer surplus. The utility of the first few litres of drinking water is very high (as it prevents death), so the first few litres would likely have more consumer surplus than subsequent litres.

The maximum amount a consumer would be willing to pay for a given quantity of a good is the sum of the maximum price they would pay for the first unit, the (lower) maximum price they would be willing to pay for the second unit, etc. Typically these prices are decreasing; they are given by the individual demand curve, which must be generated by a rational consumer who maximizes utility subject to a budget constraint .Because the demand curve is downward sloping, there is diminishing marginal utility. Diminishing marginal utility means a person receives less additional utility from an additional unit. However, the price of a product is constant for every unit at the equilibrium price. The extra money someone would be willing to pay for the number units of a product less than the equilibrium quantity and at a higher price than the equilibrium price for each of these quantities is the benefit they receive from purchasing these quantities

For a given price the consumer buys the amount for which the consumer surplus is highest. The consumer's surplus is highest at the largest number of units for which, even for the last unit, the maximum willingness to pay is not below the market price.

Consumer surplus can be used as a measurement of social welfare, first shown by Willig (1976). For a single price change, consumer surplus can provide an approximation of changes in welfare. With multiple price and/or income changes, however, consumer surplus cannot be used to approximate economic welfare because it is not single-valued anymore. More modern methods are developed later to estimate the welfare effect of price changes using consumer surplus.

The aggregate consumers' surplus is the sum of the consumer's surplus for all individual consumers. This can be represented graphically as shown in the above graph of the market demand and supply curves. It can also be said to be the maxim of satisfaction a consumer derives from particular goods and services.