Perfect Competition: An Exercise in Wistfulness.

This is the equilibrium in perfect competition:



in the short run. And in the long run:



The closest we probably have to this in real life is petrol stations. I thought I'd post this up as an education in the mechanics of economics. After all, as Auditor #9 says, we're all learners here.

It's satanic.

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

At the moment it looks like a Barnett Newman painting

"We favor the simple expression of the complex thought.

We are for the large shape because it has the impact of

the unequivocal. We wish to reassert the picture plane.

We are for flat forms because they destroy illusion and

reveal truth. "

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

I too am a thicko. But they are nice pictures...

soubresauts wrote:

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

I too am a thicko. But they are nice pictures...

Indeed, but given that it's economics, it's probably all bollix.

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

They're copy and paste jobs, so I wasn't able to list the meanings of all the lines but, here goes. Quiet in the back, this is double economics, we've got work to do!

MC=Marginal cost; the cost of the last good produced.

AC=Average cost; the average cost of each good produced.

MR=Marginal revenue; the income received from the last good sold(since a firm in PC is a price-taker, price is constant and therefore MR+AR)

AR=Average revenue; the average income received from each good sold.

D=Demand which equals AR.

The little yellow rectangle represents the SNP earned by the firm operating in PC in the short run. No, not the Scottish Nationalist Party, it's Super Normal Profit. The existence of SNP in the short run entices other firms into the market to sell goods at lower prices in order to siphon off some of that SNP.

Any questions?

riadach wrote:

soubresauts wrote:

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

I too am a thicko. But they are nice pictures...

Indeed, but given that it's economics, it's probably all bollix.

Actually, it is a load of nonsense, since markets like these rarely exist in the real world.

Ard-Taoiseach wrote:

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

They're copy and paste jobs, so I wasn't able to list the meanings of all the lines but, here goes. Quiet in the back, this is double economics, we've got work to do!

MC=Marginal cost; the cost of the last good produced.

AC=Average cost; the average cost of each good produced.

MR=Marginal revenue; the income received from the last good sold(since a firm in PC is a price-taker, price is constant and therefore MR+AR)

AR=Average revenue; the average income received from each good sold.

D=Demand which equals AR.

The little yellow rectangle represents the SNP earned by the firm operating in PC in the short run. No, not the Scottish Nationalist Party, it's Super Normal Profit. The existence of SNP in the short run entices other firms into the market to sell goods at lower prices in order to siphon off some of that SNP.

Any questions?

So it is all bollix?

riadach wrote:

Ard-Taoiseach wrote:

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

They're copy and paste jobs, so I wasn't able to list the meanings of all the lines but, here goes. Quiet in the back, this is double economics, we've got work to do!

MC=Marginal cost; the cost of the last good produced.

AC=Average cost; the average cost of each good produced.

MR=Marginal revenue; the income received from the last good sold(since a firm in PC is a price-taker, price is constant and therefore MR+AR)

AR=Average revenue; the average income received from each good sold.

D=Demand which equals AR.

The little yellow rectangle represents the SNP earned by the firm operating in PC in the short run. No, not the Scottish Nationalist Party, it's Super Normal Profit. The existence of SNP in the short run entices other firms into the market to sell goods at lower prices in order to siphon off some of that SNP.

Any questions?

So it is all bollix?

It's a theoretical exercise which illustrates the dynamics of more imperfect markets.

Ard-Taoiseach wrote:

riadach wrote:

Ard-Taoiseach wrote:

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

They're copy and paste jobs, so I wasn't able to list the meanings of all the lines but, here goes. Quiet in the back, this is double economics, we've got work to do!

MC=Marginal cost; the cost of the last good produced.

AC=Average cost; the average cost of each good produced.

MR=Marginal revenue; the income received from the last good sold(since a firm in PC is a price-taker, price is constant and therefore MR+AR)

AR=Average revenue; the average income received from each good sold.

D=Demand which equals AR.

The little yellow rectangle represents the SNP earned by the firm operating in PC in the short run. No, not the Scottish Nationalist Party, it's Super Normal Profit. The existence of SNP in the short run entices other firms into the market to sell goods at lower prices in order to siphon off some of that SNP.

Any questions?

So it is all bollix?

It's a theoretical exercise which illustrates the dynamics of more imperfect markets.

Really? Cause to me, that's exactly what bollix sounds like :-)

riadach wrote:

Ard-Taoiseach wrote:

It's a theoretical exercise which illustrates the dynamics of more imperfect markets.

Really? Cause to me, that's exactly what bollix sounds like :-)

Well...it's there to tell us about other markets. We can hold the perfectly elastic demand schedule of PC against ordinary markets in IC to see where they differ and what we can learn from that. We can also use these models to investigate whether markets are producing at lowest possible AC, ie, wasting no resources.

Ard-Taoiseach wrote:

riadach wrote:

soubresauts wrote:

Kate P wrote:

You might tell us what all the letters stand for. (label the diagram, and all that for thickos like me)

I too am a thicko. But they are nice pictures...

Indeed, but given that it's economics, it's probably all bollix.

Actually, it is a load of nonsense, since markets like these rarely exist in the real world.

Because you've to bring in externalities and public goods?
It is now increasingly clear, that externalities are all pervasive (Stiglitz etc*). So the actual equilibrium is further to the left, for cars say, than it should be. Which means we produce and consume too many cars.

There's significant discrepancies between market supply and marginal social costs and/or market demand and marginal social benefits. So by relying on market forces we consistently get inefficient allocations of productive resources - i.e produce too little of some goods and too much of others.

The mainstream view today (and Adam Smiths view) hinges on the assumption that external effects are insignificant. Which is incorrect.

And if you bring in public goods, say pollution reduction, (greenhouse gas reduction) then the actual equilibrium is further to the right. So we produce and consume too little in a market for same. The market equilibrium level of 'production' and consumption of this public good will be significantly less than the socially efficient level.

Basically it all works only if there are no external effects or public goods. Which is nonsense.

*
(Stiglitz is the nobel prize winning economist and former head of the World Bank)

Quote :

"Whenever there are “externalities”—where the actions of an individual have impacts on others for which they do not pay or for which they are not compensated—markets will not work well. Some of the important instances have been long understood—environmental externalities. Markets, by themselves, will produce too much pollution. Markets, by themselves, will also produce too little basic research. (Remember, the government was responsible for financing most of the important scientific breakthroughs, including the internet and the first telegraph line, and most of the advances in bio-tech.)

But recent research has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk markets—that is always."

from here

Pax wrote:

Because you've to bring in externalities and public goods?
It is now increasingly clear, that externalities are all pervasive (Stiglitz etc*). So the actual equilibrium is further to the left, for cars say, than it should be. Which means we produce and consume too many cars.

Oh, for sure. As well as that, we have to take into account consumers are irrational and therefore the traditional assuption of rational behaviour on the part of the consumer is a cop-out. Consumers will always make irrational choices which upset market equilibrium.

Quote :

There's significant discrepancies between market supply and marginal social costs and/or market demand and marginal social benefits. So by relying on market forces we consistently get inefficient allocations of productive resources - i.e produce too little of some goods and too much of others.

The mainstream view today (and Adam Smiths view) hinges on the assumption that external effects are insignificant. Which is incorrect.

And if you bring in public goods, say pollution reduction, (greenhouse gas reduction) then the actual equilibrium is further to the right. So we produce and consume too little in a market for same. The market equilibrium level of 'production' and consumption of this public good will be significantly less than the socially efficient level.

Basically it all works only if there are no external effects or public goods. Which is nonsense.

And you'd be right again. Economics can be very limiting in its focus, there are often too many assumptions which detrat from the realistic application of economic principles to practical situations.

Quote :

*
(Stiglitz is the nobel prize winning economist and former head of the World Bank)

I've heard of him!

Quote :

Quote :

"Whenever there are “externalities”—where the actions of an individual have impacts on others for which they do not pay or for which they are not compensated—markets will not work well. Some of the important instances have been long understood—environmental externalities. Markets, by themselves, will produce too much pollution. Markets, by themselves, will also produce too little basic research. (Remember, the government was responsible for financing most of the important scientific breakthroughs, including the internet and the first telegraph line, and most of the advances in bio-tech.)

But recent research has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk markets—that is always."

from here

I find this fascinating, if only because so many economic assumptions apparently were dragged wholesale in neoclassical economics from physical models that are now thought to be incorrect. However, that said we have to use theoretical models to map, as best as is possible, various behaviours, so the objective then presumably has to get the best possible model. How to choose? I don't know. Certainly having seen the Soviets collapse ignominiously despite supposed 'scientific' central planning I think trying to shape the world to economic theories is a fairly futile endeavour. But the reverse may be the same...

WorldbyStorm wrote:

I find this fascinating, if only because so many economic assumptions apparently were dragged wholesale in neoclassical economics from physical models that are now thought to be incorrect. However, that said we have to use theoretical models to map, as best as is possible, various behaviours, so the objective then presumably has to get the best possible model. How to choose? I don't know. Certainly having seen the Soviets collapse ignominiously despite supposed 'scientific' central planning I think trying to shape the world to economic theories is a fairly futile endeavour. But the reverse may be the same...

I see economic principles as torches with which we can illuminate our world. They can tell us things about how nations work, why such goods cost so much and others cost so little, who has the money and why and how we can make the situation fairer. That said, we should not be so arrogant as to assume that we have all the answers. Economics is a quest to higher understanding, We should always be looking to improve our knowledge and adapt our policies accordingly.

No time to contribute tonight, but really enjoying this thread. Thanks to all.

Just to correct/clarify two lines from my post above.

I should have wrote,

"It is now increasingly clear, that externalities are all pervasive (Stiglitz etc*). So the actual equilibrium is further to the left, for cars say, than what it is currently assumed to be. Which means we produce and consume too many cars."


and to clarify,


"And if you bring in public goods, say pollution reduction, (greenhouse gas reduction) then the actual equilibrium is further to the right, than what it is currently assumed to be."

Enjoying this thread too though I have to admit the textbook economics graphs don't deliver an immediate impact - I'd have to plug in data or something..

A few points that I found important/problematic during the discussion

In layman's term what does equilbrium refer to? Does it mean the optimal conditions which will allow all those petrol stations to act so as to provide the least monopolistic price? And the price at which it gives the petrol station an incentive to keep on selling because there is enough profit from that sale... I think it helps to use a real example or a few real examples to explain these things and give them context.

Pax refers to government incentive to get major infrastructure off the ground - i.e. the internet so the market model should be considered alongside other models (public) or even within another model. And I wonder is the view of models being hierarchical or parallel/equal reflective of an ideology (i.e. a socialist system would see the free market as a subset)

Why aren't externalities a part of such graphs? If they have an effect then why aren't they factored in?

Ard-Taoiseach wrote:

WorldbyStorm wrote:

I find this fascinating, if only because so many economic assumptions apparently were dragged wholesale in neoclassical economics from physical models that are now thought to be incorrect. However, that said we have to use theoretical models to map, as best as is possible, various behaviours, so the objective then presumably has to get the best possible model. How to choose? I don't know. Certainly having seen the Soviets collapse ignominiously despite supposed 'scientific' central planning I think trying to shape the world to economic theories is a fairly futile endeavour. But the reverse may be the same...

I see economic principles as torches with which we can illuminate our world. They can tell us things about how nations work, why such goods cost so much and others cost so little, who has the money and why and how we can make the situation fairer. That said, we should not be so arrogant as to assume that we have all the answers. Economics is a quest to higher understanding, We should always be looking to improve our knowledge and adapt our policies accordingly.

I'd entirely agree. But the trick is to know when to pick the theoretical model, and when to dispense with it. That's admittedly not easy.

Auditor #9 wrote:

In layman's term what does equilbrium refer to? Does it mean the optimal conditions which will allow all those petrol stations to act so as to provide the least monopolistic price? And the price at which it gives the petrol station an incentive to keep on selling because there is enough profit from that sale... I think it helps to use a real example or a few real examples to explain these things and give them context.

Equilibrium is the G-Spot in economics. Small, hard to see, but once you hit it, everything turns out wonderful. Equilibrium refers to the price at which and quantity at which firms and industries sell and produce. Equilibrium in markets is where the maximum profit is earned.

Quote :

Pax refers to government incentive to get major infrastructure off the ground - i.e. the internet so the market model should be considered alongside other models (public) or even within another model. And I wonder is the view of models being hierarchical or parallel/equal reflective of an ideology (i.e. a socialist system would see the free market as a subset)

Why aren't externalities a part of such graphs? If they have an effect then why aren't they factored in?

Externalities are hard to quantify and are a very complicated concept to effectively adjust for. Hence, they are usually ignored or assumed for the sake of simplicity.

WorldbyStorm wrote:

Ard-Taoiseach wrote:

WorldbyStorm wrote:

I find this fascinating, if only because so many economic assumptions apparently were dragged wholesale in neoclassical economics from physical models that are now thought to be incorrect. However, that said we have to use theoretical models to map, as best as is possible, various behaviours, so the objective then presumably has to get the best possible model. How to choose? I don't know. Certainly having seen the Soviets collapse ignominiously despite supposed 'scientific' central planning I think trying to shape the world to economic theories is a fairly futile endeavour. But the reverse may be the same...

I see economic principles as torches with which we can illuminate our world. They can tell us things about how nations work, why such goods cost so much and others cost so little, who has the money and why and how we can make the situation fairer. That said, we should not be so arrogant as to assume that we have all the answers. Economics is a quest to higher understanding, We should always be looking to improve our knowledge and adapt our policies accordingly.

I'd entirely agree. But the trick is to know when to pick the theoretical model, and when to dispense with it. That's admittedly not easy.

Exactly. Like the card game, you have to know when to hold 'em and when to fold 'em!

Auditor #9 wrote:

In layman's term what does equilbrium refer to? Does it mean the optimal conditions which will allow all those petrol stations to act so as to provide the least monopolistic price? And the price at which it gives the petrol station an incentive to keep on selling because there is enough profit from that sale... I think it helps to use a real example or a few real examples to explain these things and give them context.

This 'equilibrium' should be the socially efficient level of production and consumption and it's usually used in reference to adjustment by a market, i.e. it should be representing the true marginal social costs and true marginal social benefits but it never does with respect to the real world.

Auditor #9 wrote:

Pax refers to government incentive to get major infrastructure off the ground - i.e. the internet so the market model should be considered alongside other models (public) or even within another model. And I wonder is the view of models being hierarchical or parallel/equal reflective of an ideology (i.e. a socialist system would see the free market as a subset)

I think that last point would be a market socialist position within a mix economy? (personally not my ideal position) Not sure what you mean by the internet sentence as I think public utilities are better provided publicly but with participatory regulation. Kinda like the US regulated model, with workers and consumers in there but without having private companies whose profits are capped (they'd be replaced with publicly owned companies).

Auditor #9 wrote:

Why aren't externalities a part of such graphs? If they have an effect then why aren't they factored in?

Because the argument that the market is highly efficient rests on there being minimal externalities and public goods. Which is a fantasy, because externalities are all pervasive and public goods are numerous. Unfortunately mainstream orthodox economists are more than comfortable in living in a fantasy!

There's also the fact that externalising costs onto those not directly part of the market exchange - those other than the buyer and seller- is often the easiest route to profitability. You know instead of improving on the product or service you foist the costs onto others. This in turn can change preferences (endogenous preferences) into the future which further snowballs the inefficiencies.

Also, because of a host of problems, -such as lack of demand that is socially efficient, free rider and transaction problems- a public good is inefficiently and insufficiently provided by a market.

Basically, if we left it to the free market then precious little, if any, of our scarce productive resources
would be used to produce public goods no mater how valuable they really were. (such as the public good of pollution reduction say)

Pax wrote:

This 'equilibrium' should be the socially efficient level of production and consumption and it's usually used in reference to adjustment by a market, i.e. it should be representing the true marginal social costs and true marginal social benefits but it never does with respect to the real world.

Instead of marginal could you say 'optimal'? And 'socially' - does that mean within the law or socially acceptable in terms of humanity?

If you take petrol stations or video shops in Galway say, then could you apply this graph and theory to them? What about other types of shops and businesses - sandwich places around St. Stephen's Green or taxis or landscape gardening operations or plumbers? How would the graph apply to plumbers? If at all - I know you said it doesn't apply to the real world as such...

Auditor #9 wrote:

Pax wrote:

This 'equilibrium' should be the socially efficient level of production and consumption and it's usually used in reference to adjustment by a market, i.e. it should be representing the true marginal social costs and true marginal social benefits but it never does with respect to the real world.

Instead of marginal could you say 'optimal'? And 'socially' - does that mean within the law or socially acceptable in terms of humanity?

In economics marginal is usually related to "marginal revenue product" If we add one more unit of the input to all of the inputs currently used in a production process, how much would the value of output increase? The answer is the marginal revenue product of the input in question. But this contribution of an input (or marginal productivity) depends as much on the number of units of that input available, and on the quantity and quality of other, complimentary inputs, as on any intrinsic quality of the input itself.

see
http://en.wikipedia.org/wiki/Social_cost#Implications

Quote :

"(The marginal rate of transformation in production will not be equal to
the marginal rate of substitution in consumption due to the effect of
the externality and as a result Pareto optimality will not occur -- see welfare economics for an explanation.)"

[...]

But if externalities are present, the attainment of social optimality
requires that the full social costs must be considered. The socially
optimum level of output is Q_s where marginal social costs (MSC) is equal to marginal revenue (MR)."

http://en.wikipedia.org/wiki/Welfare_economics
http://www.zmag.org/books/quiet.htm


The assumption that there are no public goods or external effects is explicit in the statement of the fundamental theorem of welfare economics. It states that if all markets are in equilibrium the economy will be in a Pareto optimal state. But this is only the case if there are no external effects or public goods.

So socially efficient is the term used by market enthusiasts who continue to claim that markets allocate resources efficiently for society. It's not an ideological term or anything, whether used by most mainstream economist who are today obviously market enthusiasts, or by me.

Although when they say it within the context of reality, -- which is when markets misallocate resources when there are externalities and public goods (i.e all of the time since everyone knows there are externalities and public goods in the real world!), --then it is ideological on their part. You might notice economists giving advice in the media never bring those disequilibrating factors in, and you won't read about it in undergraduate economic textbooks.

Auditor #9 wrote:

If you take petrol stations or video shops in Galway say, then could you apply this graph and theory to them? What about other types of shops and businesses - sandwich places around St. Stephen's Green or taxis or landscape gardening operations or plumbers? How would the graph apply to plumbers? If at all - I know you said it doesn't apply to the real world as such...

I gave an example of using supply and demand curves in the price thread. See here

Quote :

You can use this elasticity in conjunction with supply and demand curves to find out the implications of assigning a price (or price controls of 10 pounds) or say whether more or less unemployment will result from a minimum wage level of 10 pounds etc. So you can have your labour supply and demand curves, but then put in elastic or inelastic demand curves. The drop in employment is greater with elastic than with inelastic curves. There's a similar situation with the price assigning or controls,

So it would apply as the prices and supply are not at the actual equilibrium and the customer's of the above's preferences are already changed to consume according to those inaccuracies. As far as I can see (I'm no economist) you are applying inaccurate graphs and theorems to an already inaccurately adjusted economy.

Like when I said: "This in turn can change preferences (endogenous preferences) into the future which further snowballs the inefficiencies."

Such as with car consumption when markets lead us to ignore negative effects, or by ignoring positive external effects leading us to consume less of goods like tropical rain forests that recycle carbon dioxide and thereby reduce global warming than is socially efficient. Instead people cut them down or burn them or whatever.

A useful example of extreme preference change, is from the book "Fast Food Nation", on how the preferences of LA's consumers are unusually negative wrt public transport and positive for private car transport*.


*

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