The market system

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

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

3. 2. Markets versus central planning • How should resources be allocated? • 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

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

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

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

7. 3.1 The role of price • Firms are price-takers • Negative relationship between price & quantity demanded • Positive relationship between price & quantity supplied • Excess supply (glut) - price falls • Excess demand (shortage) - price rises

8. 3.2 Demand • Determinants of demand • income - level & distribution • price of substitutes & complements • demography & age structure • tastes & fashion - advertising • seasonal • The demand curve • movements along the curve • Shifts in the demand curve

9. Effect of a shift in the demand curve P S g Pe1 D1 O Qe1 Q fig

10. 3.3 Elasticity of demand • (a) price elasticity of demand • (b) income elasticity of demand • (c) cross-price elasticity of demand

11. 3.4 Sales revenue • Total revenue • Marginal revenue • Price elasticity and total revenue • Uses of elasticity • Government & taxes • Business - price & taxes on sales • Central Banks - competitiveness

12. 3.5. Estimating product demand • Methods • a) consumer interviews - sampling, questionnaire design, cost • b) market experiments • c) regression analysis • Regression analysis • variable identification • obtaining data • estimation • interpretation

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

14. Effect of a shift in the supply curve P S1 g Pe1 D O Qe1 Q fig

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

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