Chapter 2

Last updated Sep 12, 2023 Edit Source

• Economic systems exist to deal with the economic problem, in order to answer the basic economic problem
• A market is said to exist when buyers and sellers exchange goods, services or resources. A market consists of three elements
• Buyers $\rightarrow$ Create Demand
• Sellers $\rightarrow$ Create Supply
• Something to exchange (goods & services)
• Markets must be voluntary exchange
• There exist and
• In the market system, the key economic questions are answered by the price mechanism
• The consumer is king (consumer sovereignty), and they determine the answers to the BEP questions.
• Markets are guided by self-interest on both the supply and demand side

• Characterised by;
• A large number of buyers and sellers
• Firms being price takers
• Homogenous products
• Easy entry into market (no barriers)

• Characterised by;
• A small number of firms
• Product differentiation
• Firms being price setters
• Restricted entry into market
• An extreme imperfect market is a monopoly market, where the market is centred around one firm.
• An oligopoly is a market with a few dominant firms

• Demand refers to the buying intentions of customers.
• This is not a want; wants are desired but demands are desires characterised by an ability to actually buy.
• Demand is governed by the law of demand
• Income effect - higher income $\rightarrow$ more purchasing power
• Substitution effect - when the price of a substitute increases, the price of the good increases as it becomes more attractive to buyers.
• The effects hold true always, as long as all other factors are constant

• There are two changes
• Shifts - a shift of the whole curve left or right (a decrease or increase) caused by a non-price factor
• Movements - a movement along the curve caused by a change in price

• Represents the sellers or producers side of the market.
• Rational, self-interested suppliers prefer to sell their output at a higher price than a lower one in order to maximise gain

• There are once again two changes
• Shifts - a shift of the whole curve left or right (a decrease or increase) caused by a non-price factor
• Movements - a movement along the curve caused by a change in price

• If we graph supply & demand on the same curve we can draw the equilibrium quantity and price as the points where the two curves intersect
• Balances buying intentions of customer with selling intentions of supplier
• If the price is below the equilibrium, there will be a shortage, and a surplus above.

• When there are shifts in either curve, the equilibrium will change. In order for there not to be a surplus or shortage, the price will naturally increase or decrease by
• Suppliers selling excess stock at a lower price
• Customers bidding up the price due to lack of supply
• In the time this takes to happen, there will be a temporary shortage or surplus

• What if both the demand and supply curves shifted at the same time?

• They could have different effects, detailed in the table below

  Type of Shift	**Effect on Price **	Effect on Quantity	(Temporary) Shortage or Surplus?
  $\uparrow D$	Increase	Increase	Shortage
  $\downarrow D$	Decrease	Decrease	Surplus
  $\uparrow S$	Decrease	Increase	Surplus
  $\downarrow S$	Increase	Decrease	Shortage
  $\uparrow D \uparrow S$	Indeterminate	Increase	N/A
  $\uparrow D \downarrow S$	Increase	Indeterminate	Shortage
  $\downarrow D \uparrow S$	Decrease	Indeterminate	Surplus
  $\downarrow D \downarrow S$	Indeterminate	Decrease	N/A

• We can observe indeterminate values for the simultaneous shifts; these depend on the magnitude of the shift

• Could increase, decrease, or stay the same