08 COMPETITIVE EQUILIBIRUM

Question 1

What is a market demand curve and a market supply curve?

Answer 1

Market Demand Curve: Shows the total quantity that all consumers are willing to buy at each price, reflecting their willingness to pay.
Market Supply Curve: Shows the total quantity that all firms are willing to supply at each price, reflecting their willingness to accept (WTA).
Equilibrium: Occurs where supply equals demand, ensuring no excess supply or shortage in the market.

Question 2

What happens when the price is not at equilibrium?

Answer 2

Above Equilibrium (P*):

Excess Supply occurs—sellers want to sell more than consumers want to buy.
Price Adjustment: Sellers lower prices to attract buyers until equilibrium is restored.

Below Equilibrium (P*):

Excess Demand occurs—buyers want to purchase more than sellers supply.
Price Adjustment: Prices rise as buyers compete, returning to equilibrium.

Question 3

What defines a price-taking firm, and how does it operate?

Answer 3

Price-Taking Firm: They can not influence the market price, also they can not benefit from choosing a price different from the market price.
Key Features:

Flat Demand Curve: Perfectly elastic demand at market price.
	
Profit Maximization: Occurs where:
MC=P=MR Since the firm is a price taker each additional unit sold bring in revenue equal to market price.
   
Supply Curve = Marginal Cost Curve: The firm produces more as price rises, provided it covers marginal costs.

Question 4

What are the characteristics of competitive equilibrium?

Answer 4

Competitive Equilibrium:

All buyers and sellers are price-takers.
Market clears (supply = demand) with no deadweight loss.
Pareto Efficiency: No one can be made better off without making someone else worse off, provided:
	- all participants are price takers
	- contracts and markets are complete
	- no external effect

Question 5

What factors can shift the supply and demand curves?

Answer 5

Supply Curve Shifts:

Technological improvements (increase supply, shifting curve right).
Market entry/exit: Profitable markets attract new firms, shifting supply right and reducing price until normal profits remain.

Demand Curve Shifts:

Changes in consumer preferences or income.
Substitute price changes.

Result: A new equilibrium forms, balancing supply and demand at a different price.

Question 6

How do taxes affect supply, demand, and market efficiency?

Answer 6

Taxes on Suppliers: Increase production costs, shifting supply upward (requiring higer price to produce same Q)
Taxes on Consumers: Reduce demand, shifting demand downward. (buying less at any given price)

Effects on Market:
- Decrease in Consumer Surplus (CS) and Producer Surplus (PS).
- Deadweight Loss: Lost welfare due to reduced trade.

Tax Burden: The less elastic side (either demand or supply) bears more of the tax burden.

Question 7

What is deadweight loss, and how is it caused by taxation?

Answer 7

Deadweight Loss (DWL): The loss of total surplus that occurs when market transactions are reduced due to taxes or other distortions.
Graphically: Represented as the white area between the demand and supply curves after taxation.
Key Insight: Although taxes cause DWL, they can improve welfare if revenue funds valuable public goods or services.

Question 8

What is perfect competition, and how does it ensure efficiency?

Answer 8

APerfect Competition Characteristics:

Homogeneous products (e.g., salt, sugar).
Many buyers and sellers, with no individual market power.
Perfect price information available to all participants.

Law of One Price: All transactions occur at the same price, ensuring Pareto efficiency with no deadweight loss.

Question 9

How do economists assess whether a market is close to perfect competition?

Answer 9

Key Tests:

Uniform Pricing: Do all trades occur at the same price?
Price Equals Marginal Cost: Are firms selling goods at a price equal to marginal cost?

Deviations: Arise when external effects, market imperfections, or incomplete contracts prevent full realization of competitive outcomes.

Question 10

What are the implications of market entry and exit for long-run equilibrium?

Answer 10

Supply curve can shift also due to market entry or exist by firms.
* If existing firms are earning economic rents (profits above the normal level) and entry costs are not prohibitively high, new firms will enter the market to take advantage of these profits.
* As more firms enter, the supply curve shifts to the right, increasing total market supply.
* This increased competition pushes the market price down until only normal profits remain (no economic rents), re-establishing a new competitive equilibrium.