The market mechanism Outline Outline 1. Introduction 1. Introduction 2. Markets versus planning 2. Markets versus planning 3. Demand and supply 3. Demand and supply 4. Movements & shifts in demand & supply 4. Movements & shifts in demand & supply

1. Introduction What is economics about? What is economics about? Scarce resources Scarce resources Resources = factors of productionResources = factors of production Choice = sacrifice Choice = sacrifice opportunity costopportunity cost Rational choice Rational choice consumers - value for moneyconsumers - value for money firms - profitfirms - profit benefits versus costsbenefits versus costs Marginal costs v. marginal benefits Marginal costs v. marginal benefits

2. Markets v. central planning How should resources be allocated? How should resources be allocated? Planned or command economy Planned or command economy Advantages Advantages high investment & economic growthhigh investment & economic growth low unemploymentlow unemployment equal distribution of incomeequal distribution of income environmentenvironment Disadvantages Disadvantages complex economy - information?complex economy - information? Inefficient allocation of resourcesInefficient allocation of resources absence of incentivesabsence of incentives loss of libertyloss of liberty

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

Totally planned economy Totally free-market economy Classifying economic systems

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

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

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

3.1 Consumer demand Determinants of consumer demand Determinants of consumer demand (a) price (a) price demand curve & demand functiondemand curve & demand function Q d = a - bP Q d = a - bP Movements along the demand curveMovements along the demand curve Price rise – move up Price rise – move up Price fall – move down Price fall – move down

fig Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) 20 Market demand (tonnes 000s) 700 A Point A Market demand for potatoes (monthly) Demand

fig Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABAB Point A B Market demand for potatoes (monthly) Demand

fig Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABCABC Point A B C Market demand for potatoes (monthly) Demand

fig Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABCDABCD Point A B C D Market demand for potatoes (monthly) Demand

fig Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABCDEABCDE Point A B C D E Market demand for potatoes (monthly) Demand

Consumer 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

Supply The supply curve & function The supply curve & function Q s = a + bP Q s = a + bP Movements along the curve Movements along the curve Price changesPrice changes Shifts in the supply curve Shifts in the supply curve Changes in other determinantsChanges in other determinants

Price (pence per kg) Quantity (tonnes: 000s) Supply a P 20 Q 100 a Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b P Q abab Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b c P Q abcabc Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b c d P Q abcdabcd Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b c d e P Q abcdeabcde Market supply of potatoes (monthly)

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