2.1 Markets

Markets include any kind of arrangement where buyers and sellers of a particular good, service or resource are linked together to carry out an exchange.

Local market: a bakery sells bread to members of the community.

National market: A local takeaway restaurant has consumers nationwide.

International market: The world oil market includes producers and consumers from different countries.

	Number of firms	Market power	Product	Barriers to entry	Examples
Perfect competition	Many small firms	none	homologous	none	agriculture
Monopoly	One large	Very significant	One, no substitutes	high	energy suppliers
Monopolistic competition	Many, relatively small firms	some	Differentiated	Very low	restaurants
Oligopoly	Few large	significant	either	high	Cars, steel

Importance of price as a signal and as an incentive in terms of resource allocation:

As signals, prices communicate information to decision-makers. As incentives, prices motivate decision-makers to respond to the information.

Demand

Demand is the willingness and ability to consume at a given time, at a given price.
The law of demand states that as price increases, demand decreases, ceteris paribus.

Determinants of demand

Number of buyers

Tastes

Income – demand increases for normal goods and decreases for inferior goods.

Prices of substitutes (if they satisfy a similar need)

Prices of complementary goods (if they tend to be used together)

Expectations of future income

Expectations of future prices

Distinction between a movement along and a shift of the demand curve

Any change in price produces a change in demand (movement). Any change in a determinant produces a change in demand (shift).

Higher level:

Exceptions to the law of demand (the upward-sloping demand curve)

Ostentatious (Veblen) goods

These are goods which display wealth pretentiously. A person derives from utility from the desire to impress other people than from the consumption itself. High prices are associated with increased social status.

Giffen goods

Staple goods which the poor buy less of when prices decrease as the increase in real income may be used to buy better quality and more expensive substitutes. On the other hand as prices rise, they have less real income to consume a better substitute, so will buy more of the staple good.

Bandwagon effect

If prices rise and there are expectations that they will rise even further, demand will increase. For example, in stock markets as the price of shares rises there is a shift of the demand curve to the right.

Supply

Supply is the willingness and ability to supply at a given time, at a given price.

The law of supply states that as the price of a good increases, its supply will increase, ceteris paribus.

Determinants of supply

Number of firms

Costs of factors of production

Technology lowers cost of production

Prices of goods the firm could produce

Expectation of future prices

Taxes as a cost of production

Subsidies reduce costs

Supply shocks, such as natural disasters.

Distinction between a movement along and a shift of the supply curve

Any change in price produces a change in quantity supplied (movement). Any change in the determinants produces a change in supply (shift).

Interaction of demand and supply

Equilibrium market clearing price and quantity occurs where the quantity that consumers are able and willing to buy are the same as the quantity suppliers are able and willing to produce.

Consumer surplus is the higher price consumers are willing to pay for a good minus the price actually paid.

Producer surplus is price received by firms minus the lowest price that they are willing to accept in order to produce the good.

Price controls

Maximum price:

Causes

To protect consumers and unusally imposed on merit goods, such as low-cost food for the poor during food shortages, rented accomodations for low income earners. 

Consequences

Shortages – price is below equilibrium, so there is excess demand and shortage of supply.

Decrease in quantity supplied – since there is a shortage.

Underallocation and allocative inefficiency of resources – too few resources are being allocated to produce the good.

Non-price rationing – favutitism

Illegal markets for a lower price

Minimum price:

Causes 

To raise income of producers of goods that experience large flunctuations or foreign competition, such as agriculture.
To protect workers by setting a minimum wage.

Consequences

Surpluses
Decrease in quantity demandedand purchased
Firm inefficiency - no incentive to reduce cost of production because of the protection of the min. price
Overallocation of resources - a larger than optimum quantity is produced
Illegal sales at prices below the floor

Price support/buffer stock schemes

Govt intervenes to stabilize prices, such as in the commodities market. A price band is set, with max. and min. prices.

An increase in supply may cause prices to fall below the set band. To prevent prices from sinking, the government buys the surplus and stores it. This shifts the demand curve to the right, so that the equilibrium is at the bottom price.
On the other hand, a decrease in supply may send prices off the roof, to an equilibrium above the price band. This causes a shortage from the supply at the top price, to the quantity demanded at top price. To intervene, the govt. sells the stored good.
Problems arise as storage costs are high. Improvements in technology suggest that surpluses are likely. It is also difficult to provide the correct price bands.

Commodity agreements

Different countries operate a buffer stock scheme together. 

Make sure you can draw diagrams explaining each case.