The market system Outline Outline 1. Introduction 1. Introduction 2. Markets versus planning 2. Markets versus planning 3. The market mechanism 3. The market mechanism 4. Estimating product demand 4. Estimating product demand

1. Introduction What is economics about? What is economics about? Scarce resources Scarce resources Choice Choice Opportunity cost Opportunity cost positivist & normative reasoning positivist & normative reasoning Some important concepts Some important concepts marginal decision-making marginal decision-making equilibrium equilibrium Methods of analysis Methods of analysis model building (theory) model building (theory)

2. Markets versus central planning How should resources be allocated? How should resources be allocated? Command economy - advantages Command economy - advantages high investment & economic growth high investment & economic growth low unemployment low unemployment equal distribution of income equal distribution of income environment environment Disadvantages Disadvantages complex economy - information? complex economy - information? Inefficient allocation of resources Inefficient allocation of resources absence of incentives absence of incentives loss of liberty loss of liberty

Free market Decentralised, self-interested behaviour. Price acts as a signal Decentralised, self-interested behaviour. Price acts as a signal resources allocated automatically resources allocated automatically efficient allocation of resources efficient allocation of resources competition enhances consumer sovereignty competition enhances consumer sovereignty efficient firms make bigger profits efficient firms make bigger profits ‘The pursuit of private gain results in the social good’ ‘The pursuit of private gain results in the social good’

Totally planned economy Totally free-market economy N. Korea Cuba China Poland France UK USA Early 1980s Early 2000s China Hong Kong Cuba China (Hong Kong) Classifying economic systems

3. The market mechanism Exchange Exchange mediated through markets where prices play a key role mediated through markets where prices play a key role Producer (supply) Producer (supply) Consumer (demand) Consumer (demand) Competitive market Competitive market medium of exchange medium of exchange competition competition full information full information strong institutions & social custom strong institutions & social custom

3.1 The role of price Firms are price-takers Firms are price-takers Negative relationship between price & quantity demanded Negative relationship between price & quantity demanded Positive relationship between price & quantity supplied Positive relationship between price & quantity supplied Excess supply (glut) - price falls Excess supply (glut) - price falls Excess demand (shortage) - price rises Excess demand (shortage) - price rises

3.2 Demand Determinants of demand Determinants of demand income - level & distribution income - level & distribution price of substitutes & complements price of substitutes & complements demography & age structure demography & age structure tastes & fashion - advertising tastes & fashion - advertising seasonal seasonal The demand curve The demand curve movements along the curve movements along the curve Shifts in the demand curve Shifts in the demand curve

fig Effect of a shift in the demand curve P Q O Pe1Pe1 Qe1Qe1 S D1D1 g

3.3 Elasticity of demand (a) price elasticity of demand (a) price elasticity of demand (b) income elasticity of demand (b) income elasticity of demand (c) cross-price elasticity of demand (c) cross-price elasticity of demand

3.4 Sales revenue Total revenue Total revenue Marginal revenue Marginal revenue Price elasticity and total revenue Price elasticity and total revenue Uses of elasticity Uses of elasticity Government & taxes Government & taxes Business - price & taxes on sales Business - price & taxes on sales Central Banks - competitiveness Central Banks - competitiveness

3.5. Estimating product demand Methods Methods a) consumer interviews - sampling, questionnaire design, cost a) consumer interviews - sampling, questionnaire design, cost b) market experiments b) market experiments c) regression analysis c) regression analysis Regression analysis Regression analysis variable identification variable identification obtaining data obtaining data estimation estimation interpretation interpretation

4. Supply Determinants of supply Determinants of supply technological innovation - product and/or process technological innovation - product and/or process change in price of factor inputs change in price of factor inputs disasters - natural & human disasters - natural & human strikes strikes regulation regulation organisation of the firm organisation of the firm The supply curve The supply curve Movements along the curve Movements along the curve Shifts in the supply curve Shifts in the supply curve

fig Effect of a shift in the supply curve P Q O Pe1Pe1 Qe1Qe1 D S1S1 g

5. The interaction of demand & supply Equilibrium price and quantity Equilibrium price and quantity Excess demand (shortages) Excess demand (shortages) Excess supply (gluts) Excess supply (gluts) Impediments to the operation of markets Impediments to the operation of markets price ceiling (e.g. rents) - under-supply price ceiling (e.g. rents) - under-supply minimum wage - unemployment minimum wage - unemployment

fig The determination of market equilibrium (potatoes: monthly) Quantity (tonnes: 000s) E D C A a c d e Supply Demand Price (pence per kg) B b