Hi mike5,
Let me address these two questions separately.
Question 1.
In the case of the individual firm with market power (meaning that it
can control its price), the demand curve of the industry is the
demand curve of the firm, since the firm is the only supplier. This
is not the case for a firm in a competitive industry, where the price
is fixed and the firm must either sell at the market price or not
sell. The competive firm is a price taker, so it's average revenue is
the price of the product.
The demand curve facing the monopoly firm is the market demand curve,
since the firm is the only supplier. The average revenue of the
monopolist is the demand curve, since it can set the price. The
monopoly firm's demand curve (or the market demand curve) is downward
sloping due to the substitution and income effects. As the price of A
rises, it becomes relatively more expensive and some of its demand is
shifted to B, so the demand for A falls [subsitition]. When the price
rises the consumer's real income falls since it costs more to buy good
A, so his demand for good A falls [income].
Aggregate demand AD is a different beast altogether. It is the total
demand of all the members of society for all goods and services. AD
is a function of the general price level P, which assumes that at P
all goods and services are in equilibrium. When the price level P
rises, the price of all goods rise, which is inflation. When the
price level falls, the price of all goods fall, which is deflation.
The downward slope of the AD curve has different causes than the
demand curve of the firm. Because we're dealing with every good and
service, not just one, there can't be a substitution effect. Or, put
another way, if the price of everything rises, it wouldn't do you any
good to shift demand from one good to another. Also, as price levels
rise, income to the factors of production will rise (including
labour), so demand may not necessarily fall since incomes may be
rising along with prices, though possibly not at the same rate. But
the AD curve does still have a negative relationship to prices because
of three factors:
1. The Wealth Effect - if income remains constant but prices rise,
real income falls. With a decrease in purchasing power consumers
become poorer and reduce consumption. So the wealth effect produces
an inverse relationship between prices and AD.
2. Rate of Interest - increased prices with a constant supply of money
cause an increase demand for liquidity of money because purchasing
power is reduced. Demand for money increases because because a
greater amount of money is needed to carry out the same volume of
transactions. With a constant money supply and a rising demand, the
price of money rises through the interest rate. As the interest rate
rises, borrowing becomes more expensive so spending will tend to fall.
Demand will start to decline. So rising prices cause a fall in AD
due to a rising interest rate.
3. Trade Effect - Inflation (a rise in the price level) causes
domestic goods to be more expensive than international goods. So
imported goods become cheaper relative to domestic goods, and demand
for imports increases. Also, foreign demand for domestic goods
decreases for the same reason. Both of these act together to decrease
demand for domestic goods as the price level rises.
Question 2.
An increase in productivity occurs when there in an increase in real
output at a given level of input. It decreases the cost to the firm
of producing a given level of ouput. For the individual firm, since
the price is set, this decrease in cost will cause an increase in
profit. Since the firm will continue produce until MR = MC, and MC
has now fallen, production will rise.
Productivity increase affects aggregate supply in a similar fashion.
The economy as a whole has become more productive, so it can now
produce more output with the same level of inputs, just like the firm
can. This causes a shift outward in the production possibility
frontier (PPF). The AS curve will shift out until it is tangent with
the new PPF curve.
You may want to review a few links that relate to this topic. There
are some excellent resources to learn about economics on the Internet,
but here are a few that ar particularly useful.
An excellent tutorial on economics which includes discussion of almost
everything I have mentioned:
http://www.pinkmonkey.com/studyguides/subjects/eco/contents.asp
For a discussion of the effect of productivity on AS:
http://www.colorado.edu/Economics/courses/econ2020/section7/section7.html
and some more information about AS here:
http://www.tutor2u.net/economics/content/topics/ad_as/aggregate_supply.htm
I hope this is clear enough for you. Please ask for clarification if
you would like to know something more.
hibiscus
Search Strategy: "aggregate supply" productivity, economics monopoly
demand curve, economics firm with "market power" |
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