1. 4-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Chapter 4 Allocation and the market system

2. 4-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives Show how the market system determines what is to be produced Examine how markets organise production Discuss how markets distribute output Illustrate how markets accommodate change Evaluate the operation of the market economy

3. 4-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Operation of the market system What is to be produced? Determined by competing buyers and sellers in both resource and product markets How would a pure market–coordinated economy decide on the types and quantities of goods to be produced?

4. 4-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Types and quantities of goods produced Determined by the motives of firms to seek profits and avoid losses Firms will produce those goods and services that result in a profit

5. 4-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Profits (or losses) Determined by: Total revenue received by the firm from the sale of a product Total costs of producing that product

6. 4-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Economic costs and profits Economic costs — payments made to obtain and retain the services of a resource, including land, labour, capital and entrepreneurial ability Normal profits — the minimum cost payment that is just sufficient to obtain and retain contribution by the entrepreneur

7. 4-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Economic profit The total revenue of a firm less all its economic costs (including the cost of entrepreneurial ability) Also known as pure profit Zero economic profit = normal profit

8. 4-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Profits and expanding industries Economic profits induce new firms to enter the industry, resulting in an expanding industry Entry of new firms increases the market supply of the product, resulting in lower prices until normal profits are restored The market supply and demand situation prevailing when economic profits become zero determines the total quantity of a product that will be produced

9. 4-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Losses and declining industries Below-normal profit induces firms to leave the industry, resulting in a declining industry As firms exit, supply decreases, and prices increase until normal profits are restored The market demand and supply that prevail at this point determines the total output of a product or service

10. 4-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Dollar votes Consumer demand determines the types and quantities of product produced Ultimately determines whether industries contract or expand Consumers register their dollar votes through the demand side of the product market

11. 4-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Derived demand The demand for resources is a derived demand Demand for resources is ultimately determined by the demand for the goods and services that the resources help produce

12. 4-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Market restraint on freedom Firms are not really ‘free’ to produce what they wish The demand decisions of consumers, restrict the choice of businesses in deciding what to produce

13. 4-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Organising production Organising production in a market economy involves: How should resources be allocated among specific industries? Which specific firms should do the producing in each industry? What combinations of resources — what technology — should each firm employ?

14. 4-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Production and profits The specific firms remaining in an industry are those employing the most efficient techniques Involves combining resources in the least-cost production method The most efficient technique depends on –Available technology –The price of the needed resources

15. 4-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Least-cost production The combination of resources which results in the lowest dollar-and-cents amount of cost Various techniques result in the employment of varying quantities of resources and differing costs Least-cost production or economic efficiency entails obtaining a given output of product with the smallest input of scare resources

16. 4-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Distributing total output Products are distributed on the basis of consumers willingness and their ability to pay the existing market price for a product Ability to pay is determined by income Willingness to buy is determined by consumers preference for the product, availability of close substitutes and their relative prices

17. 4-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Accommodating change Consumer preferences, technology and resource supplies are always changing requiring a reallocation of resources Market systems adapt through the guiding functions of prices A change in relative prices act as a signal to alter resource allocation or the distribution of output

18. 4-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Initiating progress Competitive markets provide incentives for technological advances — lower production costs and economic profits Technological advances lead to capital accumulation

19. 4-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Competition and control Competition is the mechanism of control in a market-oriented system Forces business and resource suppliers to respond to the wishes of consumers Firms and resource suppliers, seeking to further their own self-interest and operating within the framework of a highly competitive market system, and guided by an invisible hand, promote the public or social interest

20. 4-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia A preliminary evaluation of the market system A case for the market system –Allocative efficiency –Freedom of enterprise and choice A case against the market system –Demise of competition –Unequal income distribution –Market failure and government intervention: spillovers or externalities and public goods

21. 4-21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The role of government The economic role of government in modern capitalist systems has evolved, in part, to remedy perceived shortcomings of the market system

22. 4-22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Next chapter: Organisation of business in Australia