PRINCIPLES OF ECONOMICS

UNIT 4: THE MODEL OF PERFECT COMPETITION: The equilibrium

-PREDICTIONS (positive economics)

-WELFARE ANALYSIS (normative economics)

DEFINITION OF EQUILIBRIUM
EQUILIBRIUM PRICE: the price that equates the supply and the demand
EQUILIBRIUM QUANTITY: the quantity supplied and demanded at the equilibrium
price.
THE EQUILIBRIUM PRICE AND QUANTITY:

THE RELEVANCE OF EQUILIBRIUM

When quantity demanded and supplied are different we can have:
-Surplus: is an excess of supply, when we have this price goes down.
-Shortage: is an excess of demand, when we have this price goes up.
Quantity demanded: f (price, incomes, pc, ps)
Quantity supplied: f (price, technology, price of inputs , number of production,
expectation)

COMPARATIVE STATICS
-Use a model to predict how its endogenous variables change after changes in its
exogenous variables.
-Model of perfect competition:
-Endogenous variables: price, quantity
-Exogenous variables: consumer income, technology, prices of other goods;…

MOVEMENT ALONG DEMAND OR CHANGE IN QUANTITY DEMANDED

SHIFTS IN DEMAND OR CHANGES IN THE DEMAND

-A 3-step recipe:
1-What did it change: demand, supply or both?
2-In which direction?
3-How did it affect the equilibrium?

EXCERCISES OF COMPARATIVE STATIC:

-What happens to price and quantity if the supply and demand shift?
Supply does Supply Supply
not change Increases Decreases

Demand does P equal P decreases P increases

not change Q equal Q increases Q decreases
Demand P increases P indeterm. P increases
Increases Q increases Q increases Q indeterm.
Demand P decreases P decreases P indeterm.
Decreases Q decreases Q indeterm. Q decreases
WELFARE ECONOMICS:
-Use a model to evaluate the allocation of resources of an institution.
-Here, we use the model of perfect competition to evaluate whether the market
allocates the resources efficiently

MEASURING WELFARE
-The consumer surplus is the gains of the buyer thanks to the existence of the market.
-The producer surplus is the gains of the seller thanks to the existence of the market.
-The total (or social) surplus is the sum of the consumer surplus and the producer
surplus.

THE ALLOCATION OF RESOURCES:

1-HOW MANY UNITS?
The quantity that maximizes total surplus (maximizes welfare)
2-WHO PRODUCES?
The producers with the lowest costs
3- WHO CONSUMES?
The consumers that value the good the most.