Preliminary Topic Three Markets

The role of the market

A market is a situation in which buyers and sellers are in contact with each other for the purpose of exchange. There are 2 main types: 1. Product market: the interaction of demand for and supply of the outputs of production, ie. goods + services. 2. Factor market: a market for any input into the production process, including land, labour, capital and enterprise. Product market and Factor market interact to determine Equilibrium. Equilibrium is when Demand and supply equals. The Market Equilibrium determine:

What and how much is produced How output is produced To whom final output is distributed

Determining solutions to the economic problem Price Mechanism: the system where the forces of demand and supply determine the prices of commodities.
The price mechanism is the interaction of demand and supply, which determines a price and quantity that best satisfies individual wants with the limited resources available to firms. This is called price equilibrium. Giving a solution to the economic problem. (Satisfies both consumers and firms)

The importance of relative price in reflecting opportunity costs in the goods and Services and factor markets
The relative price - a ratio between any two prices Opportunity Costs - refers to what we have to give up in order for us to get what we want. It represents the alternative forgone. The relative price paid by consumers for goods and services reflects their opportunity costs. The factor market (natural,capital and human) determine the opportunity costs of productive resources. Relative price can also be used to help determine how best to allocate scarce resources. E.g. Opportunity Cost and Relative prices Movie tickets $10 Theatre Tickets $30 Opportunity Cost of a Theatre Ticket 3 movie ticket Opportunity Cost of a Movie ticket 0.33 of a theatre ticket

Demand and supply Demand

Demand is the quantity of goods and services, consumer are willing and able to pay at a given time.

Law of demand
Law of demand: states the lower the price of a good, the greater the demand will be and vice versa.

Individual and market demand

Individual demand: Demand of each individual consumer for a particular good or service. Market demand: Demand by all consumers for a particular goods or services.

The demand curve

A contraction in demand occurs when an increase in price causes the quantity demanded to fall. An expansion in demand occurs when a decrease in price causes the quantity demanded to rise. Movement of the curve occurs due to changes in demand.

Factors affecting demand price, income, population, tastes, prices of substitutes and complements, expected future prices
Price Income Population Tastes Price of substitutes and complements The higher the price, lower demand Higher income, more consume Growing population = more potential consumers Influences what consumers wants to buy If the price of good increases, it is expected for the quantity demanded for a substitute good to increase. Complements a good that is used with another good If a consumer expects the price of a good to go up in the future, they would consume and increase demand for the product

Expected future prices

Movements along the demand curve and shifts of the demand curve

Contraction and Expansion: Price change and the other determinants are kept constant. Shift in demand curve: Demand change and the other determinants are kept constant Shift (right or left): changes other factors

Movement (along): only changes in price

Up: contraction, when price causes Right: increase in demand. Consumers more willing to pay for quantity demanded. given quantity at higher price. Consumers will demand more of a good at a given price level Down: expansion, when price causes quantity demanded. Left: decrease in demand. Consumers less willing to pay for given quantity at same price. Consumers will demand less of a good at a given price level

Supply Law of supply

The higher the price of a good, the greater is the quantity supplied, and vice versa.

Individual and market supply

Individual: Supply by individual producers of particular good or service Market: Supply by all firms of a particular good or service

The supply curve

Shows the relationship between prices, quantity and supply

Movements along the supply curve and shifts of the supply curve
Price Change: Contraction: a decrease in supply, due to an decrease in the price of the good Expansion: an increase in supply, due to an increase in the price of a good

Movement (along): only changes in price Up: expansion, when price causes quantity supplied. Down: contraction, when price causes quantity supplied.

Shift (right or left): changes other factors Right: increase in supply. Firms can supply more at same price, or same quantity at a lower price. Left: decrease in supply. Firms supply less at same price, or same quantity at a higher price.

Increase

Decrease

Factors affecting supply Price of factors of production

Any fall in cost of production would allow firm to supply more of good A rise in cost of production would make it more difficult for firms to maintain present supply Price of other goods may encourage producers to switch Positive expectations are likely to result in increased supply. An increase number of sellers = increase in supply New technology will lower cost of production and increase supply

Price of substitutes and complements Expected future prices Number of suppliers Technology Market price Market equilibrium using diagrams

Market equilibrium: occurs when 1. Quantity demanded = Quantity supplied 2. The market clears (no excess supply or demand) 3. There is no tendency to change

Movement to equilibrium
If the prices of goods or services are higher or lower than equilibrium, disequilibrium occurs. Excess Supply If prices are above equilibrium, supply will be greater than demand, that is, there will be an excess of a goods that are left unsold, and forcing the prices to be lower until the surplus is removed. This is called excess supply. Excess Demand If prices are below equilibrium, the demand for a good exceeds the supply. Producers then can sell their goods for higher prices until equilibrium is reached. This is called Excess Demand

Effects of changes in supply and/or demand on equilibrium market price and quantity through the use of diagrams
1.An increase in demand results in an increase in equilibrium price and an increase in equilibrium quantity

2. A Decrease in quantity demanded results in decrease in equilibrium price and a decrease in equilibrium quantity.

3.An increase in quantity supplied results in a decrease in equilibrium price and an increase in equilibrium quantity.

4. A decrease in quantity supplied results in an increase in equilibrium price and a decrease in equilibrium quantity.

Effects of changing levels of competition and market power on price and output
Market power: being able to prices above competitive equilibrium without losing all customers. If the level of competition decreases, a firm will have increased market power. This increase in market power allows them to have more influence over the market price. A firm that has no competition (monopoly) can increase the price of a product by reducing output.

Alternatives to market solutions the role of government Ceiling prices

A price ceiling is when the government sets a maximum price for a good. This can be set to make a good or service more accessible to the community. It creates excess demand and a shortfall of supply

Floor prices
A price floor is when the government sets a minimum price for a good. This is done to guarantee producers a minimum price for their output It creates a shortfall of demand and excess supply
Price ceiling: maximum price able to charge for a commodity Price floor: minimum price that can be charged for commodity Reduces prices, quantity shortages Affects distribution of income Increases price, quantity excess Affects distribution of income

Market price to high Market price to low

Market failure Situation where the market fails to allocate resources efficiently Merit goods Goods not produced in sufficient quantity by private sector, as they dont place sufficient value on them, eg. Education, health. Merit goods provide positive externalities Public goods
Public goods are goods or services that are accessible to the community.

Externalities
Negative Externalities are goods or services that are harmful to society or environment A government places taxes on goods that produce negative externalities to increase equilibrium price, decrease equilibrium quantity and hence discourage use Positive externalities are goods and services beneficial to society Government subside goods that produce positive externalities to decrease equilibrium price, increase equilibrium quantity and hence encourage use

Price elasticity of demand Significance of price elasticity of demand market research

Firms marketing department researches the possible outcomes of a price change. If the good is elastic, a price rise could cause the demand for that product to be reduced If the good were inelastic, a price rise would have little affect on the demand for that product.

Price elasticity
Elasticity of Demand refers to the responsive of demand for a good in relation to a change in price

Elastic
A little change in price leads to a large change in quantity

Inelastic and unit elastic

Inelastic a large change in price leads to little change in quantity Unit elastic - change in price is proportional change in quantity (total amount spent by consumers remains same)

Calculation of elasticity using total outlay method

Total Outlay= Price x Quantity Falling- Relatively elastic Unchanged- Unit elasticity Rising- Relatively inelasticity

Price 10 9 8 7 6 5 4 3 2 1

Quantity demanded 1 2 3 4 5 6 7 8 9 10

Total Outlay 10 18 Falling 24 28 30 30 Unchanged 28 24 Rising 18 10

Price Elasticity of demand Relatively elastic

Unit elastic

Relatively inelastic

Factors affecting elasticity of demand Necessities and luxuries

Luxury goods tend to have an elastic demand and necessities tend to be inelastic. Existence of close substitutes Where a lot of goods are substitutable results in relative demand Proportion of income spent on the good A low prices good which makes up small of consumers income is relatively inelastic The length of time since a price change Demand becomes more elastic the greater the length of time since the price change. This is because consumers have time to respond to price changes and switch products.

Price elasticity of supply

The responsiveness of supply of a good in relation to change in price

Elastic supply
A strong response to a fall in price

Inelastic supply
A weak response to a fall in price

Factors affecting elasticity of supply Ability to hold and Store Stock. The ability to hold stock will affect the ease at
which producers can respond to price changes. The easier it is to hold stock the more elastic the supply. Whereas perishable goods is relatively inelastic. Excess capacity. If a firm is not operating with its existing resources at full capacity, supply is will elastic. This is because they now have allowance to respond quickly to any price increase simply by using existing resources more intensively, as opposed to half capacity.

Variations in competition Market structures

Market Structure Pure Competition

Number and Size Product of Firms Characteristics Many firms, very Homogeneous small products

Barriers to Entry Examples

No barriers to entry

Fruit and vegetables, fish markets Motels, restaurants TV stations, airlines

Monopolistic competition Oligopoly

Many firms, relatively small A few firms, relatively large

Differentiated products Generally differentiated products No close substitutes

Small barriers to entry High barriers to entry

Monopoly

One firm, large

Extremely high barriers to entry

Water supply