Title: Applied Micro Economics Problem Solving Essay Example

Title: Applied Micro Economics Problem Solving

Question 1

A purely competitive market refers to a market where the prices are determined by market forces (Blanchard & Guah, 1988). Such a market has a big pool of competitors selling the similar products, meaning that consumers will have little or no reason to choose against a product. The market in this case will be selling only wheat and competing with products from other countries.

Given that the wheat is sold in a perfectly competitive market, the prevailing price will tend towards an equilibrium price as market forces come into play (Smith, 1962). It refers to the price at which the quantity of wheat demanded by consumers equals the quantity supplied. This situation is such that, whenever the price of wheat is above or below the equilibrium price, the forces of demand and supply will result to there being surplus or shortage respectively. This can be illustrated in the diagram below;

Title: Applied Micro Economics Problem Solving

Figure 1: Demand and Supply diagram for a Purely Competitive Market

The equilibrium price in the above diagram is 60, therefore, whenever the price is above or below this value, market pressure drives it towards the equilibrium value. It is due to consumer behavior in a competitive market. For instance, a price of 80 units would lead to surplus in the market forcing the suppliers of the wheat to cut prices. Due to the high demand, consumers would prefer to purchase at lower prices while producers would prefer to take reduced prices so as to sell. The price would therefore tend towards an equilibrium value which is lower.

On the other hand, at a price of 20 units, there would be a shortage of the wheat in the market and prices would then rise to accommodate the shortage. Consumers in such a case would prefer to pay a higher price to get the product they want as suppliers also take advantage of the high demand.

In both situations, as the prices move towards the equilibrium, the quantity of surplus and shortages diminishes. The equilibrium price is achieved at the point of intersection, where the quantity demanded equals the quantity supplied.

Question 2

The expectation of a high wheat supply level by consumers clearly affects the price sensitivity of demand of the product. However, this effect significantly depends of the whether the expectation is strong or weak (Suleymanova & Wey, 2012). A strong expectation means the consumers are stubborn to the effects of market forces making the current price is less sensitive to changes in supply. For the case of the wheat market in Australia, the demand is taken to be price sensitive and therefore, the effect of future expectation can be explained using the demand and supply model.

(Chatterjee & Crosbie, 2000) noted that consumers use available information to develop unbiased forecasts about the future product attributes and prices. In the Australian market, the consumer did expect that the supply of wheat would be high in the future due to the anticipated bumper harvest, meaning that they expected that the price of wheat would fall. It implies therefore that the current demand for wheat would fall significantly as the consumers hold out for lower prices in the future. In this case, the demand is assumed to be price sensitive.

The expectation causes the demand curve to shift to the left as consumers demand less even with a constant price. Wheat is however a perishable good, thus, the prevailing price will tend to decrease in the long run as the producers aim to sell off their stock. As more and more consumers hold out for lower prices in the future, the current price would be pushed further down until the remaining supply can only meet the prevailing demand. The equilibrium price in such a case therefore would be lower than normal due to the expectation. It is therefore important that the consumers always have the right information about future product output so as not to inappropriately affect current prices.

References

Blanchard, O.J. and Quah, D., 1988. The dynamic effects of aggregate demand and supply disturbances.

Chatterjee, R., Eliashberg, J. and Rao, V.R., 2000. Dynamic models incorporating competition. New Product Diffusion Models, pp.49-73.

Smith, V.L., 1962. An experimental study of competitive market behavior. The Journal of Political Economy, pp.111-137.

Suleymanova, I. and Wey, C., 2012. On the role of consumer expectations in markets with network effects. Journal of Economics, 105(2), pp.101-127.