Chapter 2: Competitive markets and how they work.

Studying markets you, firstly, have to understand for yourself what is MARKET. The best explanation of this term is a place  where and when buyers and sellers meet each other to trade or exchange products. Here some good examples of markets (just for better understanding)

-          foreign exchange market

-          stock market

-          food market

-          holiday market

-          housing market

-          labour market.

-          Etc.

 

You also have to recognize two main characteristics of markets:

1)      It is a physical place or some mechanism whereby (internet) where buyers and sellers can meet  together to exchange products. As we know from Chapter 1 there are two ways of exchange goods (products) : barter, money.

2)      A willingness to trade or exchange goods.

 

Because of specialization (Ch.1) all markets divided into sub-markets. Sub-market – is a recognized or distinguishable part of market. Also known as market segment. Some examples of sub-markets: food or non-food sub-markets.

 

Demand

This term is used very often by economists. Demand is the quantity of the product that consumers are able and willing to purchase (buy) at various prices  over a period of time. There are two types of demand: notional demand (the desire for a product) and effective demand (the willingness and ability to buy a product). All economists use effective demand, because effective demand is a real ability to purchase product, not just wants (notional demand).

All companies,  who are selling products, know relationships between price and demand well, because it is one of the main points in selling products. So lets have a look on changing of prices and changing of quantity demanded:

-          the lower price, the more will be demanded;

-          the higher price, the less will be demanded.

As we economists, we have to know which economic indicators we can use to show demand and price (relationships).

Demand curve ( shows the relationships between the quantity demanded and the price of product)

Also we need a source of data.

Demand schedule ( the data that is used to draw the demand curve for a product)

Lets have a look on this with particular example.

 

Demand schedule for a one-week self-catering holiday in Ibiza in June.

 

Price per person (pounds)	Quantity demanded
500	300
450	500
400	650
350	800
300	1,000
250	1,150
200	1,300
150	1,500

As we can see if the price of holidays falls quantity demanded increases. Using the market demand curve it is possible to extrapolate the expected quantity demanded at any particular price. For example, at the price of 325, 900 holidays will be demanded.

In this case we see that the demand curve is a straight line, it also can be curvilinear. On the next example we see how individual’s demand for trips to the cinema (per month) changes as the price of cinema admission changes.

 

Lets take point A (with price 4 and quantity demand 1) on the curve. If the price will fall, quantity demanded will increase. For example, price fall from 4 pounds to 3 pounds. As we see quantity demanded increased from 1 to 2. So we got point B (with price 3 and quantity demand 2). These changes are often called as movement along the demand curve (this is response to a change in the price of a product).

 

An extension in demand is where a fall in price results in a greater quantity demanded.

A contraction in demand is where a rise in price results in a lesser quantity demanded.

 

Consumer surplus

Sometimes people are ready to demand more than it expected. For example in cinema industry: when the new film is showing, people want to go to the cinema in the first day of release and they are ready to pay money more than the price. In this case we will get more profit than we expected before. This example illustrate us the concept of consumer surplus.

Consumer surplus is the extra amount that a consumer is willing to pay for product above the price that is actually paid.

Next graphs shows us how consumer surplus works. As we can see that colored area indicates the additional money that this consumer is willing to pay to consume the product when the price is P and when Q is the quantity demanded.

 

If the market price changes from P, the consumer surplus will also change. A fall in the price to P₁ results in an increase in consumer surplus. The additional consumer surplus is represented by the area PEFP₁.

 

Lets go back to demand. So we’ve already decided that the price has influence on demand. Lets find out non-price factors effecting demand. Economists recognize three non-price factors, such as:

-          consumer income;

-          the prices of other products;

-          tastes and fashion.

 

Lets have a look briefly on this factors.

 

1) Consumer income.

 

Consumer income is very important, because people need money (income) to consume a product. There are two types of income:

-  disposable income (income after taxes on income have been deducted and state benefits have been added)

- real disposable income (income after taxes on income have been deducted and state benefits have been added and the result has been adjusted to take into account changes in the price level)

 

We can also divide all goods (from consumer income side) into two groups:

-          normal goods ( goods for which an increase in income leads to an increase in demand) Cars, holidays, televisions, computer equipment, etc.

-          inferior goods (goods for which an increase in income leads to a fall in demand) Goods with poor quality.

 

 

2)      The prices of other products.

 

Demand can be affected by prices of another goods it two cases:

-          when the products are complements ( goods for there is joint demand) Car prices and prices for oil; car prices and car insurance prices; the price of air- travel rickets and prices of air-includes holidays. 

-          when the products are substitutes (competing goods) Car and train travel; the price of BMW and AUDI.

You have to remember :

-          if goods are complements (A and B) and price of good A falls, demand for good B increases.

-          If goods are substitutes (F and C) and price for C falls, demand for good F decreases.

 

3)      Tastes and fashion

 

Changing in tastes can involve changing in demand of different products. For new products (if people like it) demand will increase.

 

A change in demand due to a change on non-price factors.

Change in demand due to	Effect on the demand curve
An increase in consumer income A rise in the price of substitutes A fall in the price of complements A positive change in tastes and fashion	Shift to the RIGHT
An fall in consumer income A fall in the price of substitutes A rise in the price of complements A negative change in tastes and fashion	Shift to the LEFT

 

 

 

Supply

To meet people’s needs firms and companies have to supply. Actually, the reason of supply for firms and companies is getting profit ( the difference between the total revenue of a producer and total cost.). So lets have a look on the definition of supply. Supply – is the quantity of a product that producers are willing and able to provide at different market prices over a period of time.

As demand, we also use supply curve and supply schedule to show the relationships between price and quantity of supplied.

Lets have a look on example.

Price per person (pounds)	Quantity supplied
500	1,200
450	1,150
400	1,100
350	1,050
300	1,000
250	950
200	900
150	850

 

 

Producer surplus.

Producer surplus – is the difference between the price a producer is willing to accept and what it is actually paid.

For better understanding look at the graph below.

 

Suppose the typical selling price is P and at this price Q is the quantity supplied. The producer surplus is the colored area above the supply curve below the price line at P. Anything the firm sells below the price P is because it is willing to sell to consumers at this price. As we can see a fall in price reduces producer surplus, rise in price increase producer surplus.

 

Other factors affecting supply:

-          costs of production;

-          size and nature of the industry;

-          government policy;

-          other factors.

 

Cost of production.

There are many factors affecting cost of production. Lets notice some of them:

1)      Land . For example rise in price in oil can cause increase in price for food, because firms have to pay more for transporting their goods (food).

2)      Labour. Cost of production depends on cost of labour a lot., because you need workers to produce or transfer goods and services.

Size and nature of the industry.

The main thing is competition. If the industry is large, there are a lot of competitors and prices are, probably, lower, because of big amount of suppliers.

Government policy.

Government can effect supply in different ways. Here are some of them:

-          taxation. For example VAT (Value Added Tax)

-          legislation

-          regulation

-          giving subsidies to firms (financial help from government)

 

Change in supply due to change in non-price factors.

Change in supply due to	Effect on the supply curve
A fall in raw material costs An improvement in labour efficiency A reduction in the rate of indirect taxation Any other positive factor	Shift to the RIGHT
An increase in raw material costs An increase in labour costs An increase in the rate of indirect taxation Any other negative factor	Shift to the LEFT

 

 

How prices are determined.

For almost all costumers the price is the main point when they are buying products. So, what is it???? Price is the amount of that is paid for a given amount of a particular good or service. Price is determined by supply and demand. The equilibrium price is when demand and supply are equal. For better understanding lets look on example.

Price per person (pounds)	Quantity demanded	Quantity supplied
500	300	1,200
450	500	1,150
400	650	1,100
350	800	1,050
300	1,000	1,000
250	1,150	950
200	1,300	900
150	1,500	850

 

The equilibrium price is 250 per holiday, where demand and supply curves intersect or cross. At this point, the equilibrium quantity is 1,100 holidays. The total expenditure by consumers, and hence revenue for producers, is 250x1,100 = 275,000 pounds.

 

Effects of a change in demand or supply on the equilibrium position.

Three reasons of change :

-          a change in demand, whereby the demand curve shifts to the right or to the left;

-           a change in supply, whereby the supply curve shifts to the right or to the left;

-          a more or less simultaneous change in demand or supply.

 

Lets have a look on this changes on the graphs.

 

1)      Effects of change in demand on the equilibrium position.

2)      Effects of change in supply on the equilibrium position.

3)      Effects of a simultaneous fall in demand and supply in the equilibrium position.

 

Elasticity

 

We have already looked on factors effecting supply and demand, but we didn’t find out how we can measure this changes. Elasticity is the term that is used to measure the extent to which buyers and sellers respond any particular changes in market conditions.

Types of elasticity:

1)      Price elasticity  of demand (PED)

Formula: PED = %changes in quantity demanded / %changes in price.

PED shows how demand responses to changes in the price.

When PED is more than 1, it means price elastic( demand responses a lot to changes in prices). Cola, Holidays.

When PED is less than 1, it means price inelastic( demand responses not to much to changes in prices).Petrol, water.

2)      Income elasticity of demand (YED)

Formula: YED = %changes in quantity demanded / %changes in income.

YED shows how demand responses to changes in income.

If YED is positive, it means normal goods.

When YED is negative, it means inferior goods.

When YED is more than 1, it means income elastic( goods for which a change in income produces a greater proportionate change in demand).

When YED is less than 1, it means income inelastic( goods for which a change in income produces a less proportionate change in demand).

3)      Cross elasticity of demand(XED)

Formula: %change in quantity demanded of product A / %change in price of product B

XED shows how demand of one product responses to change in the price of another product.

When XED is positive, two goods are substitutes.

When XED is positive, two goods are complements.

When XED equals zero, it means there is no particular relationships.

4)      Price elasticity of supply(PES)

Formula:  PES = %changes in quantity supplied / %changes in price.

PES indicates how much additional supply a producer is willing to provide for the market following a change in price of the product.

When PES is between 0 and 1, it means that the elasticity of supply is inelastic.

When PES is greater than 1, it means that the elasticity of supply is elastic.

When PES equal to 1, it means that change in price causes an exactly proportional change on the quantity supplied.

 

How business can use the term Elasticity you can find in detail examples in our books.

 

Allocative efficiency.

Efficiency is where the best use of resources is made for the benefit of consumers.

Allocative efficiency is where consumer satisfaction is maximized.

This is fine in theory, but it doesn’t always happen. On example below we three points (Q1 Q Q2)

The points Q1 and Q2 are allocated inefficiency, because in this points quantity demanded is not being met with quantity supplied. So the  allocative efficiency is point Q. 

 

Chapter 1: The reasons for individuals, organisations, and societies having to make choises.

When we start to study a new subject firstly we have do decide what our subject is about. So, Economics….. We hear this term very often in our modern life. Especially people who watch TV news and read newspapers. Anyway, lets talk about economics. To find out a definition of our subject lets try to guess what is the most important case of studying Economics ( in the global view). The most important case of studying Economics is solution Economics problem. Economic problem is how to allocate scarce resources in the most effective way among alternative uses. So we can maintain that Economics is the study of how to allocate scarce resources in the most effective way. Actually, there are a lot of different definitions of term Economics, because every economist understands Economics in different ways. We also can hear that ‘ Economics is a social science that studies human behavior as a relationship between ends and scarce means which have alternative uses. That is, economics is the study of the trade-offs involved when choosing between alternative sets of decisions.’ ( Lionel Robbins, economist).

Economics consists of to parts:

Macroeconomics and Microeconomics

 

Microeconomics includes study of how households (a group of people whose spending decisions are connected) and firms make decisions in markets.

Macroeconomics includes study of issues that effect economies as whole.

 

Just for better understanding this information I will give you some examples:

 

Microeconomics: individual decisions, demand, supply

Macroeconomics: government policy, exports, imports, inflation, unemployment, economic growth.

 

As I sad before the basic economic problem is scarce resources. The resources available  in an economy are known as  factors of production. There are four main types of factors of production:

-          Land. This is natural resource. It includes mineral deposits like oil, coal, also it includes river and lakes, trees and plants in terms of using in agriculture area, also see, sun in terms of using in tourism area. You have to remember that the main reward of land is rent.

-          Labour. This is the human resources. It is very important for economy. To increase labour government usually provide training and education. In poor countries the cost of labour is much lower than, for example in the Europe Union. So we can see that a lot of big companies, who produce foods, allocate their factories in the poor countries to spend less on production.

-          Capital. This is form of physical resources. To better understanding, capital is all stuff that companies own( factories, office blocks, machinery, information technology, transport, etc.)

-          Entrepreneurship. This is very particular form of human capital. It covers a group of people who have their own forms or want to start own business. In economics this group of people known as enterprises.  

 

Lets talk about the main economic concepts:

Scarcity (a situation where there no enough resources to meet all people’s needs and wants)

Choice (the selection of appropriate alternarives)

Opportunity cost( the cost of the next best alternative foregone.)

 

So lets talk about needs and wants. You have to understand the differents of this two terms. Needs – is something, with the lack of this people cannot live( for example: water, bread, etc.) But wants – is something, that people want (for example: car, big house, etc.) Just for understanding I will give you this example:

I need to eat(needs), but I want a chocolate(wants).

So as we can see that needs are more important than wants.

Wants are infinite. Even you are Roman Abramovich or Bill Gates, you will always want something new like new car, new mobile phone, etc. Because everyday something new is appearing.

Needs and wants are very important for economists or for entrepreneurs. All firms, managers always think about what to produce and where to produce goods or services to meet people’s needs and wants (this is the main reason of receiving profits for entrepreneurs).

Making choices people always meet with term opportunity cost. For better understanding lets look at this with example. Suppose you have 100 pounds. What will you do with this money? You have to choice where and on what will you spend them. For example you can go and buy a mobile phone, you also can go and buy new headphones, etc. So as we can see you will have a lot of opportunities to spend your money. But you can’t do everything, because you have scarce resources (only 100 pounds). So you have to give up of something to do other thing. In our example you have to give up with buying headphones to buy a mobile phone or you have to give up with buying mobile phone to buy headphones. This is just a simple example for better understanding. Actually, the term opportunity cost is used by all companies to decide how to produce and sell good in most effective way.

 

Specialization and exchange.

  
The problem of scarcity can also includes specialization( situation when individual workers, firms, regions or economies concentrate on a particular task or upon producing some goods and services and not others. This involves that different individuals, firms or countries can produce different goods or services. That’s why it’s necessary to have the term exchange. This term is used on trade between individuals, firms and countries. One of the form of exchange is barter. Barter is when somebody(individual, firm, country) buy goods or services  from others( individual, firm, country ) paying by goods or services. This kind of exchange is very often in poor countries, because some poor countries don’t have enough money to cover all trade relationships. But almost all countries in the world use money for exchange.

In developed economies trade can be internal(domestic) and external (international). Internal trade means all trade relationships inside the country, external trade means trade relationships between different countries.

We can also use the term specialization when we talk about labour. To make our production more effective we have to allocate our labour and give different tasks to different group of labour. Economists call this process Division of labour. So the main case of division of labour is to increase productivity( output, or production of a good or service, per worker). Very goof example of division of labour and high productivity is car industry. In this industry(almost like in others) workers do different jobs. Because some workers can do some job better than another, that’s why we see that all companies are divided in different departments. The main reason for this is higher productivity.

 

Production possibility curves.

Production possibility curve shows the maximum quantities of different combinations of output of two products, given current resources and the state of technology. To show how this economic model works lets imagine that economy produce only two products( cars and television sets).

Lets draw the Production possibility curve.

 

 

For example maximum quantity of produced cars will be 1000 units, and maximum quantity of produced TVs will be 2000. So if we produce only cars we can produce 1000 units of cars, if we produce only TVs we can produce 2000 units. Lets imagine that we want to produce both of them. We have to decide which combination will be the most effective.

Suppose we will produce 250 units of cars and 500 units of TVs(point C). As we can see that point C is allocated inside PPC( on the left side of PPC). This means that we are using not all our resources.

Suppose we will produce 750 units of cars and 1000 units of TVs (point A). As we can see point A is allocated on the PPC, so this means that we are using all our resources.

Suppose we will produce more than 750 units of cars and more than 1500 units of TVs. In this case we will have a lack of our resources, because this point will be outside PPC( on the right side of PPC)

As we can see deciding witch way is more effective we use the term trade-off (the calculation involved in deciding on whether to give up one good for another).

Because of technological advance in all forms in production we can have a change in the PPC.

Increases in ability to produce more TVs

 

In this case we can see that we can produce more TVs using the same amount of resources.

 

Also PPC can shift to the left

 

 

and to the right.

 

 

The causes if this shifts are:

1)      Economic growth (more recourses) It will shift PPC to the right(increase).

2)      Technological changes. Also have influence on the PPC, as I sad before.

 

 

 

Economic systems and the role of the market.

Economic system is the way in which production is organized in a country or group of countries.

This term will respect to:

-          what goods and services are to be produced

-          how these goods and services are produced

-          who should receive these goods and services.

Three main types of economic systems:

1)      MARKET ECONOMY

2)      THE COMMAND OR CENTRALLY PLANNED ECONOMY

3)      MIXED ECONOMY.

 

 

1) Market economy

Resources are located by the forces of demand and supply. Decisions of allocation resources are  taken by millions of people and thousands of firms. The main point of market system is that government doesn’t participate in the market. This blocks show us a chain of  operations in market(the price mechanism at work).

 

 

 

  2)The Command or Centrally  Planned economy.

In this economic system the government has a central role in all decisions that are made. The government also control prices and amount of wages. The government develops the plan, that has to be keeping to achieve  economic growth. Goof example of this system was USSR, where government controlled whole economy and private property didn’t exist, everything was public.

3) Mixed economic system.

This system includes characteristics if both systems. There are public and private property. Decisions involve interaction between firms, labour and the government.