ECONOMICS TOPIC THREE – 9.3 MARKETS

8/12/2019 ECONOMICS TOPIC THREE 9.3 MARKETS

1/8

Preliminary Economics Sabrina Ho

TOPIC THREE 9.3 MARKETS

The focus of this topic is the operation of markets. The way in which market prices are determinedand the need and means available for governments to intervene in markets are highlighted.

The role of the market

A marketis a situation in which buyers and sellers are in contact with each other for the purpose of

exchange. arkets don!t have to be physical places due to changes in technology andtelecommunications" enabling exchange to take place through mobiles" telephones and computers.

Product or good a!d er"#ce market# where and how final goods and services are boughtand sold. e.g. markets for fresh fruits and vegetables" meats and fish" groceries goods" and personalservice. They allocate goods to consumers who are prepared to pay the highest price.

$actormarket# markets where the factors of production are bought and old such as the labourmarket" the capital market" the market for raw materials and the market for management orentrepreneurial resources. They allocate scarce resources to make the goods in highest demandand provide income for consumers.

Product and factor markets interact to determine e$uilibrium prices and $uantities of the variousgoods" services and resources bought and sold

Determining solutions to the economic problem

The importance of relative price in reflecting opportunity costs in the goods and services and

factor marketsThe interaction between demand and supply determines e$uilibrium prices in markets. The prices ofgoods and services serve % functions in market economies such as Australia&

'. Pr#ce reflect the relat#"e carc#t% of good a!d er"#cein terms of their supply

(. Pr#ce hel& to allocate reourcein the production of goods and services which yield thehighest returns to producers

). Pr#ce act a #!ce!t#"eor signals for producers and entrepreneurs to take risks in organisingthe factors of production to produce the goods and services demanded by consumers

*. Pr#ce act a a rat#o!#!g de"#cein enabling markets to clear. e.g. surplus of goods in a marketwill usually lead to a fall in price" to encourage demand and discourage production. +onversely" ashortage of goods in a market would lead to a rise in price" causing demand to fall and productionor supply to rise

%. Pr#ce are a! e'u#l#(rat#!g de"#cein markets. +hanges in price bring about e$uilibriumbetween demand and supply if they are in a dise$uilibrium situation such as a shortage or surplusof goods

)ema!d a!d u&&l%

Demand# the $uantity of a particular good or service that consumers are willing and able topurchase at various price levels at a given point in time

Law of demand, individual and market demand, the demand curve

*a+ofdema!d#states that as prices rise the $uantity demanded by consumers falls" and as pricesfalls" the $uantity demanded rises

I!d#"#dual dema!d# the demand of each individual consumer for a particular good or service

Market dema!d# demands by all consumers for a particular good or service. ,t is obtained bysumming the $uantities demanded by all individual consumers at the various price levels


2/8


Factors affecting demand price, income, population, tastes, prices of substitutes and

complements, expected future priceso Pr#ce of other good a!d er"#ce# e.g. if the price of a substitute good falls" the demand for

its substitute will decrease. e.g. tea and coffee" public transport and car,f the price of a complementary good rises" the demand for its complement will decreaseo E,&ected future &r#ce# if consumers expect the price of the product will rise in the future" they

may decide to buy -demand that good before the price riseo Co!umer tate a!d &refere!ce

o Co!umer #!come# as income falls in the economy" demand for luxuries should decrease

o S#-e a!d age d#tr#(ut#o! of &o&ulat#o!# as the population increases" the demand for most

goods and services should increase. ,f a population gets older" the pattern of demand will seeincrease for goods appropriate for that populations! age /ET 0A+T12S A00E+T,3/ SHEET

,f a change in these factors causes demand to increase" it is shown as a movement to the right ofthe demand curve from 4'4'to 4(4(

,f a change in these factors causes demand to decrease" it is shown as a movement to the left of thedemand curve from 4'4'to 4(4(

Movements along the demand curve and shifts of the demand curve

5hen the price of good changes" the change in demand is called a co!tract#o!or an e,&a!#o!.

5hen the price of the good or service rises" demands contract and when prices falls" demandsexpand.

,n the diagram" a rise in the price from 1P'to 1P(results in acontraction in demand from 16'to 16(and a correspondingmovement upwards to the left along the existing demand curve.,f price falls from 1P'to 1P)" demand expands from 16'to16).

The demand for a good or service will change due to factorsother than the price of that good or service.

Supply# the $uantity of a good or service that all firms in aparticular industry are willing and able to offer for sale at different price levels" at a given point intime

Law of supply, individual and market supply, the supply curve

*a+ of u&&l%# as the price of a product rises" the $uantity supplied by producers will also risebecause it is more profitable.This essentially represents the marketsupplyof a particular product,which is the sum of the individualfirmsuppliesof individual producersat the various price levels.

Co!tract#o!# in supply occurs when a decrease in price from 1P'to1P(causes $uality supplied to fall from 16'to 16(E,&a!#o!# in supply occurs when an increase in price in 1P'to 1P)causes $uantity supplied to rise from 16'to 16)

Factors affecting supply


3/8


# ,mprovements in technology# +hanges in the cost of factors of production. E.g. if wages rise" a firm may retrench some of itsworkers" decreasing its ability to supply# Price of other goods" the suppliers could produce. E.g. if the price of wheat falls" relative to theprice of corn" farmers may plant more corn" increasing the supply# +limate" seasons and natural ha7ards# Personal preferences of suppliers to enter an industry or leave

Movements along the supply curve and shifts of the supply curve,ncrease in supply 4ecrease in supply

Marketprice

Market euilibrium where at a certain price level" the $uantity supplied and the $uantity

demanded of a commodity are e$ual. This means that the market clears -there is no excess supplyor demand and there is no tendency for change in either price or $uantity

Pr#cemecha!#m# process by which the forces of supply and demand interact to determine themarket price at which goods and services are sold and the $uantity produced

Movement to euilibriumSellers are selling the good at the price 1P'" which is below the e$uilibrium price 1PE. At this price-1P'" there is a shortage of goods because consumers are demanding 164 and suppliers aresupplying at 16S. The excess demand" results in consumers forcing the price up as they competefor the limited supply. As the price rises" demand contracts and supply expands. This will continueuntil e$uilibrium is established at 1PE.

Suppliers are selling their good at the price 1P'" which is above e$uilibrium price. At the price 1P'"there is excess supply e$ual to 646S. To sell this excess supply" suppliers will lower the priceresulting in an expansion in demand and a contraction in supply. The price will fall until e$uilibrium isachieved at 1PE.

!ffects of changes in supply and"or demand on euilibrium market price and uantity through the


4/8


use of diagrams

I!creae#!dema!d# this diagram is for the umbrellamarket and Sydney experiences a long spell of wetweather

)ecreae #! dema!d# the diagram represents theinternational airline market. Assume we have a globalrecession

I!creae #! u&&l%# the diagram represents the marketfor computers and computer manufacturing technologyimproves

)ecreae #! u&&l%# the diagram represents 1ne4irection concert tickets and it is discovered one membergets sick and they cancel some concerts


5/8


!ffects of changing levels of competition and market power on price and output

Alternatives to market solutions the role of government5hen a free market fails to produce a satisfactory outcome for society" it is called market fa#lure. ,fthis occurs" the government may intervene and influence the price or $uantity being supplied in themarket.This intervention can take form of&'. Price ceiling

(. Price floor ). ,ndirect taxes -/ST*. Subsidies -financial assistance%. 6uotas -production limit8. /overnment production -public services e.g. public hospitals" public schools" public transport

#eiling prices, floor prices

Pr#cece#l#!g&A price ceiling is imposed by the government" if the market price is considered too high. E.g. if anecessity such as milk or water had a market price that was too high" the government will set amaximum price or price ceiling below the e$uilibrium price.

A &r#cece#l#!gredistributes money away from sellers and to consumers. The problem with it is itcreates excess demand.

Pr#cefloor&,f the market sets an e$uilibrium that is too low for producers to be profitable" the government mayconsider setting a minimum price" or price floor above the e$uilibrium price. ,t would do this fornecessities such as food to ensure producers don!t leave the market and create a shortage thefollowing year.

A &r#ce floorredistributes income away from consumers who now pay a higher price and to theproducers or sellers. The problem with it is it creates excess supply.

Market failure merit goods, public goods, externalities

Price elasticity of demand# PE)9 refers to the responsiveness of demand to changes in the priceof the good or service demanded

$ignificance of price elasticity of demand market research

Business firmsneed to understand price elasticity of demand for the goods they sell in order todecide on their optimal pricing strategy. If demand was relatively elastic, the firm would know thatlowering the price would greatly expand the volume of sales, thus increasing total revenue. On theother hand, if demand was relatively inelastic, the firm could increase the price, which would also


6/8


lead to an increase in total revenue, since the reduction in sales would be less than the priceincrease. Awareness of the elasticity of demand in different price ranges is important for determiningthe best pricing strategy for a firm and in deciding whether or not to change prices.

Governmentneeds to understand price elasticity of demand when pricing the goods and servicesthat it provides for the community (such as public transport fares). Further, it also needs to be able topredict the effects of changes in the level of any indirect taxes, such as sales taxes, excise dutiesand special levies that it imposes on goods such as alcohol, tobacco products and petrol. These

taxes and charges raise the price of the goods affected, and the government needs to be able togauge the responsiveness of demand in order to accurately estimate the amount of revenue they willraise.

%rice elasticity

# !lastic, inelastic and unit elastic,f the demand for a good is !ot "er% re&o!#"eto a change in price" its demand is relat#"el% &r#ce#!elat#c

,f the demand for a good is "er% re&o!#"eto a change in price" its demand is relat#"el% &r#ceelat#c

,f the change in price is e'ual #! &ro&ort#o!al cha!gein the $uantity demanded" demand has u!#telat#c#t%and the total spending -outlay by consumers is unchanged

Perfectl% #!elat#c dema!d# customers are willing to pay any price inorder to obtain a given $uantity of a good or service. This is representedby a vertical demand curve.

Perfectly elastic demand consumerswill demand an infinite (unlimited) quantityat a certain price, but nothing at all at aprice above this. As no such situation

exists in reality, this situation can be regarded as merely theoretical.This is represented by a horizontal demand curve.


7/8


# #alculation of elasticity using total outlay methodTotal Outla% Pr#ce , /ua!t#t% )ema!ded

Total outlay can also be called total re"e!ue

,f price and total outlay are moving in o&&o#te d#rect#o!"the PE4 is elat#c -E1& Emma 1!rourke. E.g. if prices riseand total outlay falls" the PE4 is elastic for that good

,f price and total outlay are moving in the ame d#rect#o!0the PE4 is #!elat#c-,S. E.g. if price and total outlay areboth rising or both falling

,f total outlay is unchanged from one price to the next"demand is experiencingu!#t elat#c#t%

Factors affecting elasticity of demand

# 5hether that good is a luxury or necessity# 5hether that good has any close substitutes# 5hether the good is addictive or habit9forming# Proportion of income spent on the good# :ength of time between the price change and the change in demand

Price elasticity of supply# PES9 measures the responsiveness of $uantity supplied to a change inprice

!lastic supply, inelastic supply

,f the supply for a good is !ot "er% re&o!#"eto a change in price" its supply is relat#"el% &r#ce#!elat#c

,f the supply for a good is "er% re&o!#"eto a change in price" its supply is relat#"el% &r#ce elat#c

,f the supply in price is e'ual #! &ro&ort#o!al cha!gein the $uantity supplied" supply has u!#telat#c#t%

Factors affecting elasticity of supply &no calculations are reuired


8/8


# T#me lag after a &r#ce cha!ge1The greater the amount of time that producers have to respond to a price change" the more elasticthe supply for the product. ,n the time immediately after the price change" the supply of mostproducers would be perfectly inelastic because producers can!t increase any of their input. Thereforein the short run" the price inelasticity of supply increases" although likely to be relatively inelastic. ,nthe long run" however the producers would be able to increase in production in response to a pricechange" making supply relatively price elastic# The a(#l#t% to hold a!d tore tock1

,t is possible to store some goods and not offer them for sale when there is a downturn in marketconditions and the price falls. This stock of good is known as #!"e!tor%-the total stock of goods andservices held by a firm at a point in time" which is intended for sale to consumers" and can beoffered for sale when prices rise again. The ability to hold stock will affect the ease with whichproducers can respond to price changes. The easier it is to hold stock" the more elastic the supply.E.g. highly perishable items" such as fresh fruits would be difficult to hold in stock" where as holdingstock for durable goods such as furniture" would make it easier" making supply more elastic# E,ce ca&ac#t%1Excess capacity exists when a firm is not using its existing resources to their full capacity. Supplywill be elastic when firms have excess capacity" because they can respond $uickly to any priceincrease by using their existing resources more intensively. E.g. a firm operating its plant andmachinery at only half capacity could double its output very $uickly in response to a price increase.

1n the other hand" supply will tend to be inelastic when resources are already being used at fullcapacity.

2ar#at#o! #! com&et#t#o!

Market &o+er# of a firm refers to its ability to raise its prices above the market e$uilibrium price.0irms with a high degree of market power are either monopolies or are so large" they dominate theirmarket and act as the market leaders exercising monopoly like power.

,f a market is dominated by a large firm" there is less competitions in that market. +ompetition canbe either price or non9price competition. firms can compete by either lowering prices or using non9

price means" such as advertising" after sale services" and warranty. The greater the degree ofcompetition in the market" the greater the number of firms competing against each other.

Markettructure# number of firms in an industry and the type of goods being sold

Market structures

%ure competition

Monopolistic competition

'ligopoly

Monopoly

Market tructure um(er a!d #-eof f#rm

Productcharacter#t#c

4arr#er toe!tr%

E,am&le

Pure competition any firms" verysmall

Homogeneousproducts

3o barriers toentry

0ruits andvegetables" fishmarkets

onopolisticcompetition

any firms"relatively small

4ifferentiatedproducts

2elatively easyentry

otels" restaurants

1ligopoly A few" relativelylarge firms

;suallydifferentiatedproducts

High barriers toentry

Supermarkets"banks" oilcompanies" airlines

onopoly 1ne firm only"

generally large

3o close

substitutes

Extremely high

barriers to entry

5ater supply

ECONOMICS TOPIC THREE – 9.3 MARKETS

Documents

Transcript of ECONOMICS TOPIC THREE – 9.3 MARKETS