Markets and Market Structure

What is a Market?

A market is a group of economic agents who are trading a good or service, governed by explicit or implicit rules for trading. Markets can be physical (e.g., a local gasoline market) or virtual (e.g., online shopping platforms).

• Participants: Buyers (e.g., car owners needing fuel) and sellers (e.g., gas stations).

• Rules for Trading: Sellers announce prices; buyers purchase if willing and able to pay.

• Examples: Markets exist for goods and services such as haircuts, steel, cars, bars, tomatoes, and even dating services.

• Location: Markets may have a physical location or operate online (e.g., Amazon, Airbnb).

Perfectly Competitive Markets

Definition and Key Features

Economists often study perfectly competitive markets as a benchmark for understanding real-world markets.

• Identical Goods: All sellers offer an identical product or service.

• Price-Takers: No individual buyer or seller can influence the market price; all accept the prevailing market price.

• Single Market Price: Goods are traded at one price, known as the market price.

Examples and Non-Examples

• Commodities: Agricultural products and raw materials (e.g., steel, aluminum, soybeans, rice) often approximate perfect competition.

• Non-Examples: The smartphone market is not perfectly competitive due to product differentiation (e.g., iPhone vs. Samsung), price-setting behavior, and price variation across brands and models.

Why Study Perfect Competition?

• Few markets are perfectly competitive, but many are nearly perfectly competitive.

• Perfect competition serves as a useful benchmark for analyzing real markets.

• Choosing the right model for analysis requires knowledge and experience.

Building a Model: The Competitive Market

Assumptions and Principles

To model a competitive market, economists make simplifying assumptions:

• Identical goods are sold.

• All agents are price-takers.

The model is based on two key economic principles:

1. Optimization: Buyers and sellers try to do the best they can.

2. Equilibrium: What does the market look like when everyone optimizes?

Demand

Individual Demand

The quantity demanded is the amount of a good that a buyer is willing and able to purchase at a given price.

• Example: At each price, Camilla's annual demand for petrol is given in the table below.

• As price rises, quantity demanded falls (the law of demand).

• The demand curve plots price against quantity demanded, typically downward sloping.

Willingness to Pay and Marginal Benefit

• Willingness to Pay (WTP): The maximum price a buyer is willing to pay for an additional unit of a good.

• Marginal Benefit: The additional benefit from consuming one more unit, reflected in the WTP for that unit.

• Example: If Camilla has already bought 199 liters, her WTP for the 200th liter is the price at which she would buy one more liter.

Market Demand

The market demand curve is the horizontal sum of all individual demand curves at each price.

• For two buyers, Camilla and Peter, the market demand at each price is the sum of their individual demands.

Shifts vs. Movements Along the Demand Curve

• Movement along the curve: Caused by a change in the good's own price.

• Shift of the curve: Caused by changes in preferences, income, prices of related goods, number of buyers, or expectations about the future.

Supply

Individual Supply

The quantity supplied is the amount of a good that a seller is willing and able to sell at a given price.

• Example: ExxonMobil's supply schedule for oil at different prices.

• The supply curve is typically upward sloping: as price increases, quantity supplied increases.

• Marginal Cost: The additional cost of producing one more unit. The supply curve reflects the marginal cost of production.

Market Supply

The market supply curve is the horizontal sum of all individual supply curves at each price.

• For two suppliers, the market supply at each price is the sum of their individual supplies.

Shifts vs. Movements Along the Supply Curve

• Movement along the curve: Caused by a change in the good's own price.

• Shift of the curve: Caused by changes in input prices, technology, number of sellers, or expectations about the future.

Market Equilibrium

Equilibrium Price and Quantity

Market equilibrium occurs where the demand and supply curves intersect. At this point, the quantity demanded equals the quantity supplied.

• Equilibrium Price (): The price at which the market clears.

• Equilibrium Quantity (): The quantity bought and sold at the equilibrium price.

Example: In the world oil market, the equilibrium price might be $100 per barrel, with an equilibrium quantity of 35 billion barrels per year.

Disequilibrium: Excess Supply and Excess Demand

• Excess Supply (Surplus): Occurs when price is above equilibrium; quantity supplied exceeds quantity demanded. This leads to downward pressure on price.

• Excess Demand (Shortage): Occurs when price is below equilibrium; quantity demanded exceeds quantity supplied. This leads to upward pressure on price.

Shifts in Demand and Supply

• A shift in demand or supply will change the equilibrium price and quantity.

• Example: A leftward shift in supply (e.g., due to reduced production) raises price and lowers quantity.

• Example: A leftward shift in demand (e.g., due to environmental regulations) lowers both price and quantity.

• If both curves shift, the effect on equilibrium depends on the relative magnitude of the shifts.

Real-World Application: Oil Market Shocks

• Demand Shock: COVID-19 pandemic reduced demand for oil.

• Supply Shock: Saudi Arabia increased supply in a price war with Russia.

• Result: Oil prices fell sharply from $60 to $20 per barrel in early 2020.

Key Terms (Norwegian-English)

• Etterspørselskurve: Demand curve

• Marginalnytte (Grensenytte): Marginal benefit

• Ulikevekt: Disequilibrium

• Fullkommen konkurranse: Perfect competition

• Prisfast kvantumstilpasser: Price-taking quantity adjuster

• Betalingsvillighet: Willingness to pay

• Grensekostnad: Marginal cost

• Tilbudskurve: Supply curve

• Overskuddsetterspørsel: Excess demand

• Overskuddstilbud: Excess supply

Key Equations

• Law of Demand: , where is quantity demanded and is price;

• Law of Supply: , where is quantity supplied and is price;

• Equilibrium Condition: at

• Marginal Cost: , where is total cost and is quantity