- 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
| 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
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 =
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.
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