The market mechanismThe market mechanism

OutlineOutline 1. Introduction1. Introduction

2. Markets versus planning2. Markets versus planning

3. Demand and supply3. Demand and supply

4. Movements & shifts in demand & supply4. Movements & shifts in demand & supply

1. Introduction1. Introduction What is economics about?What is economics about?

Scarce resources Scarce resources • Resources = factors of productionResources = factors of production

Choice = sacrificeChoice = sacrifice• opportunity costopportunity cost

Rational choiceRational choice• consumers - ‘value for money’consumers - ‘value for money’• firms - profitfirms - profit• benefits versus costsbenefits versus costs

Marginal costs v. marginal benefitsMarginal costs v. marginal benefits

2. Markets v. central planning2. Markets v. central planning How should resources be allocated?How should resources be allocated?

Planned or command economy Planned or command economy AdvantagesAdvantages

• high investment & economic growthhigh investment & economic growth

• low unemploymentlow unemployment

• equal distribution of incomeequal distribution of income

• environmentenvironment DisadvantagesDisadvantages

• complex economy - information?complex economy - information?

• Inefficient allocation of resourcesInefficient allocation of resources

• absence of incentivesabsence of incentives

• loss of libertyloss of liberty

Free marketFree market Decentralised decision-makingDecentralised decision-making Self-interested behaviourSelf-interested behaviour

resources allocated automaticallyresources allocated automatically efficient allocation of resourcesefficient allocation of resources incentives - e.g. efficient firms make bigger incentives - e.g. efficient firms make bigger

profitsprofits competition enhances consumer sovereigntycompetition enhances consumer sovereignty

‘‘The pursuit of private gain results in the The pursuit of private gain results in the social good’social good’

Mixed economiesMixed economies

Totallyplannedeconomy

Totallyfree-marketeconomy

Classifying economic systemsClassifying economic systems

Totallyplannedeconomy

Totallyfree-marketeconomy

N. KoreaCuba Poland France

UKUSA

Early 1980s

China HongKong

Classifying economic systemsClassifying economic systems

Totallyplannedeconomy

Totallyfree-marketeconomy

N. Korea

N. Korea

Cuba

China

Poland

Poland France

France UK

UKUSA

USA

Early 1980s

Early 2000s

China HongKong

CubaChina(HongKong)

Classifying economic systemsClassifying economic systems

3. The market - demand & supply 3. The market - demand & supply ExchangeExchange

markets - prices act as a signal markets - prices act as a signal Producer (supply)Producer (supply) Consumer (demand)Consumer (demand)

Competitive marketCompetitive market medium of exchangemedium of exchange competitioncompetition full informationfull information strong institutions & social customstrong institutions & social custom

3.1 Consumer demand3.1 Consumer demand

Determinants of consumer demand Determinants of consumer demand (a) price (a) price

• demand curve & demand functiondemand curve & demand function QQdd= a - bP= a - bP

• Movements along the demand curveMovements along the demand curve Price rise – move upPrice rise – move up Price fall – move downPrice fall – move down

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Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Demand

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Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Demand

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Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Demand

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Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Demand

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Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Market demand for potatoes Market demand for potatoes (monthly)(monthly)

Demand

Consumer demandConsumer demand Determinants of demand (shifts)Determinants of demand (shifts)

(b) income - level & distribution(b) income - level & distribution (c) price of substitutes & complements(c) price of substitutes & complements (d) demography & age structure(d) demography & age structure (e) tastes & fashion - advertising(e) tastes & fashion - advertising (f) seasonal(f) seasonal

• (b)-(f) lead to shifts in the demand curve (b)-(f) lead to shifts in the demand curve

SupplySupply

The supply curve & functionThe supply curve & function QQss = a + bP = a + bP Movements along the curveMovements along the curve

• Price changesPrice changes Shifts in the supply curveShifts in the supply curve

• Changes in other determinantsChanges in other determinants

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Market supply of potatoes (monthly)Market supply of potatoes (monthly)

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Market supply of potatoes (monthly)Market supply of potatoes (monthly)

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Market supply of potatoes (monthly)Market supply of potatoes (monthly)

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Market supply of potatoes (monthly)Market supply of potatoes (monthly)

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100200350530700

abcde

Market supply of potatoes (monthly)Market supply of potatoes (monthly)

3.2 Supply3.2 Supply

Determinants of supply (shifts)Determinants of supply (shifts)

technological innovation - product and/or technological innovation - product and/or processprocess

change in price of factor inputschange in price of factor inputs disasters - natural & humandisasters - natural & human strikes, regulation, organisation of the strikes, regulation, organisation of the

firm firm