Microeconomics

Vivekananda Mukherjee
Department of Economics and Finance, BITS-Pilani, Hyderabad Campus
Lecture 4
Summary

• Existence, uniqueness and stability of competitive equilibrium

• Vernon Smith’s experiment about competitive market mechanism
• Use of elasticity data and linear market demand and supply curve for
market analysis
UNDERSTANDING AND PREDICTING THE EFFECTS OF
CHANGING MARKET CONDITIONS

Demand: Q = a − bP (1)

Supply: Q = c + dP (2)

• Step 1:

E = (P/Q)(ΔQ/ΔP)

Demand: ED = −b(P*/Q*) (3)

Supply: ES = d(P*/Q*) (4)

• Step 2:

a = Q* + bP*
∗ ∗
𝑐 =𝑄 −𝑑𝑃 (5)
 UNDERSTANDING AND PREDICTING THE
EFFECTS OF CHANGING MARKET CONDITIONS

Because this example is set in 2005–2007, all prices are measured in

2005 dollars. Here are some rough figures:
•2005–7 world price = $50 per barrel
•World demand and total supply = 34 billion barrels per year (bb/yr)
•OPEC supply = 14 bb/yr
•Competitive (non-OPEC) supply = 20 bb/yr
The following table gives price elasticity estimates for oil supply and
demand:
Short Run Long Run
World demand: -0.05 -0.40

Competitive supply: 0.10 0.40

What happens to world price if Saudi Arabia stops selling at the world market 3bb/yr?
Solution
Derivation of short run demand function:
Step 1:
.
Step 2:
 .
Short run demand function: .

Derivation of short run competitive supply function:

Step 1:
.
Step 2:
 .
Short run competitive supply function: .
Short run supply function:
Saudi Arabia cuts back its sale in the world market by 3bb/year

New OPEC supply bb/yr bb/yr.

New short run supply function:

Short run demand function: .

New price ??

Exercise. Find the price in world oil market in the long run.

Problem set 1
Consumer Behavior Theory

Firms’ earning (revenue)

Product Market Individuals’ expenditure

Buyer Seller
Individuals Firms
[Utility(Happiness) [Profit maximizers]
maximizers] Seller Buyer

Individuals’ earning (income)

Firms’ expenditure (cost)
Factor Market
Consumer’s Behavior in the Product Market

Firms’ earning (revenue)

Product Market Individuals’ expenditure

Buyer Seller
Individuals Firms
[Utility(Happiness) [Profit maximizers]
maximizers] Seller Buyer

Individuals’ earning (income)

Firms’ expenditure (cost)
Factor Market
 Basic Principle

Preference of the
individual over
Budget Constraint:
consumption/commodity
bundles

The most preferred bundle is chosen

subject to budget constraint

for all