The market mechanism

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The market mechanism

• Outline
• 1. Introduction
• 2. Markets versus planning
• 3. Demand and supply
• 4. Movements shifts in demand supply

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1. Introduction

• What is economics about?
• Scarce resources
• Resources factors of production
• Choice sacrifice
• opportunity cost
• Rational choice
• consumers - value for money
• firms - profit
• benefits versus costs
• Marginal costs v. marginal benefits

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2. Markets v. central planning

• How should resources be allocated?
• Planned or command economy
• Advantages
• high investment economic growth
• low unemployment
• equal distribution of income
• environment
• Disadvantages
• complex economy - information?
• Inefficient allocation of resources
• absence of incentives
• loss of liberty

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Free market

• Decentralised decision-making
• Self-interested behaviour
• resources allocated automatically
• efficient allocation of resources
• incentives - e.g. efficient firms make bigger
  profits
• competition enhances consumer sovereignty
• The pursuit of private gain results in the
  social good
• Mixed economies

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

• Exchange
• markets - prices act as a signal
• Producer (supply)
• Consumer (demand)
• Competitive market
• medium of exchange
• competition
• full information
• strong institutions social custom

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3.1 Consumer demand

• Determinants of consumer demand
• (a) price
• demand curve demand function
• Qd a - bP
• Movements along the demand curve
• Price rise move up
• Price fall move down

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Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700
Price (pence per kg) 20
Point
A
Price (pence per kg)
A
Demand
Quantity (tonnes 000s)
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Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500
Price (pence per kg) 20 40
Point
A B
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
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Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500 350
Price (pence per kg) 20 40 60
Point
A B C
C
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
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Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500 350 200
Price (pence per kg) 20 40 60 80
Point
A B C D
D
C
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
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Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500 350 200 100
Price (pence per kg) 20 40 60 80 100
Point
E
A B C D E
D
C
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
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Consumer demand

• Determinants of demand (shifts)
• (b) income - level distribution
• (c) price of substitutes complements
• (d) demography age structure
• (e) tastes fashion - advertising
• (f) seasonal
• (b)-(f) lead to shifts in the demand curve

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Supply

• The supply curve function
• Qs a bP
• Movements along the curve
• Price changes
• Shifts in the supply curve
• Changes in other determinants

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Market supply of potatoes (monthly)
Supply
P 20
Q 100
a
Price (pence per kg)
a
Quantity (tonnes 000s)
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Market supply of potatoes (monthly)
Supply
P 20 40
Q 100 200
a b
Price (pence per kg)
b
a
Quantity (tonnes 000s)
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Market supply of potatoes (monthly)
Supply
P 20 40 60
Q 100 200 350
a b c
c
Price (pence per kg)
b
a
Quantity (tonnes 000s)
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Market supply of potatoes (monthly)
Supply
d
P 20 40 60 80
Q 100 200 350 530
a b c d
c
Price (pence per kg)
b
a
Quantity (tonnes 000s)
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Market supply of potatoes (monthly)
e
Supply
d
P 20 40 60 80 100
Q 100 200 350 530 700
a b c d e
c
Price (pence per kg)
b
a
Quantity (tonnes 000s)
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3.2 Supply

• Determinants of supply (shifts)
• technological innovation - product and/or process
• change in price of factor inputs
• disasters - natural human
• strikes, regulation, organisation of the firm