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Introduction to Markets - Coggle Diagram

- - - - Price is what the buyer pays for a specific goods or service.
      - Quantity is the total number of units purchased at that price.
      - The demand curve is downward sloping and shows the relationship between price and quantity.
      - This means that the higher the price is, the lower demand is.
      - The law of demand shows the inverse relationship between price and quantity, assuming all other variables are constant.
    - - Elasticity measures the responsiveness of one variable to the change in another variable.
      - Price elasticity = % change in quantity demanded ÷ % change in price.
      - Elastic demand is where the PED > 1.
        
        If a product is price elastic in demand:
        
        Decreasing price = increases total revenue.
        
        Increasing price = decreases total revenue.
      - Inelastic demand is where the PED < 1.
        
        Decreasing price = decreases total revenue.
        
        Increasing price = increases total revenue.
      - Unitary elasticity is where the PED = 1.
      - PED is almost always negative as an increase in price would result in a decrease in demand. But you may see some questions refer to it as positive for ease.
      - Income elasticity of demand (YED)
        
        Income elasticity of demand = % change in quantity demanded ÷ % change in income.
        
        Normal goods have a positive income elasticity, YED > 0 (income rises; demand increases).
        
        Inferior goods have negative income elasticity, YED < 0 (income rises; demand decreases).
      - Cross Price elasticity of demand (XED)
        
        Cross-price elasticity of demand is when a change in the price of one good can change the quantity demanded of another.
        
        Cross-price elasticity of demand = % change in quantity demanded of good A ÷ % change in the price of good B.
        
        If XED is close to zero this would suggest that the goods are unrelated.
      - Perfectly elastic demand - PED = +/- infinity and any price increase will mean that demand drops to 0
      - Perfectly inelastic demand - PED = zero.
        Any price change won't affect demand.
      - If there is unitary elasticity, any percentage change in price will be offset by an equivalent percentage change in quantity demanded so for moderate price changes, revenue will not change.
  - - - Rational agents are agents (people, governments or companies/producers) who use utility theory to guide their decision-making.
      - Producers
        
        Traditional theory says that firms will try and maximise profits, and this is how most of their utility is gained.
        
        Reasons for wanting to maximise profit include:
        
        Survival.
        
        To reinvest profits.
        
        To offer managers and staff members better rewards.
        
        In a world of asymmetric information, firms may have other objectives too, such as:
        
        Maximising revenue.
        
        Maximising market share (and gaining monopoly power).
        
        Ethical objectives (e.g. supporting the local economy).
        
        Governments
        
        Consumers
        
        Governments
        
        Governments should act in ways that best serve the population and, roughly speaking, try to maximise overall welfare.
        
        This includes:
        
        Achieving economic growth.
        
        Reducing inflation.
        
        Reducing or eliminating unemployment.
        
        Achieving a balance between payments in and payments out (equilibrium).
        
        Consumers
      - Consumers
        
        Consumers are said to act rationally and maximise utility within the limits of their income.
        
        Different consumers will have different interpretations of utility. One consumer might prioritise financial security (e.g. in saving for a property). Another consumer might want flashy clothes.
        
        Consumers may also want to maximise their work-life balance (i.e. maximising their income while enjoying as much free time as they can). Consumers act as workers when they do this.
  - - - Changes in the price of inputs (these will affect the cost of production).
      - A discovery of a new technology (allowing the firm to produce at a lower cost).
      - Changes in Government policy.
      - What could cause an increase
        
        Rise in price
        
        Better technology and more efficient production
        
        Government subsidies
    - - PES = % change in quantity supplied ÷ % change in price.
      - So an elasticity of supply greater than one means that the percentage change in quantity supplied will be greater than a one % price change.
      - Elastic supply, PES > 1.
      - So a higher PES value means more elastic supply.
      - Inelastic supply, 1 > PES > 0
      - Unit elasticity of supply, PES = 1.
      - Percentage change in quantity supplied = percentage change in price.
      - Perishable Goods
        
        Products that are likely to perish because of weather conditions will have a more inelastic supply.
        
        E.g crops and agriculture.
        
        Recessionary period
      - During periods of high unemployment, we tend to see a more elastic supply.
        
        This is because if a firm tried to expand their production, they would have a larger pool of labour to hire.
      - Firms that are agile keep high levels of stock.
        
        This makes supply price elastic as they can quickly respond to increases in demand by releasing more stock.
      - More generally, firms with agile factor mobility will be more price elastic in supply.
  - - - This is the only price where the amount consumers want to buy is equal to the amount producers want to sell.
      - If the market is at equilibrium, there is no reason to move away.
      - Supply and demand (market forces) dictate the equilibrium quantity and price in a free market.
    - - Disequilibrium is when the market is not at a stable price and quantity.
      - If the market is not at equilibrium, economic pressure arises to move the market towards a stable price and quantity.
      - E.g if petrol prices were to rise above their equilibrium level, the market would respond and the quantity demanded would fall.
    - - Excess supply and demand occur at disequilibrium.
      - The higher price makes it more profitable for petrol producers, so output expands.
      - The difference between the quantity demanded and quantity supplied is now the excess supply.
      - When quantity demanded exceeds quantity supplied, there is excess demand.
    - - The market price is unstable when there is excess demand or supply.
      - Excess supply will force producers to cut the price because it is better to sell at a lower price than not at all. Others will follow.
      - Excess demand will signal to producers they can generate more profit by raising the price and will do so.
      - So excess demand and supply can lead to price change.
  - - - Incentive function: rising prices encourage firms to expand their level of output because of higher profits.
      - Signalling function: if the price of a good changes, this signals to the consumer or producer that they should change their level of consumption or production.
      - Rationing function: resources are scarce. The price of a good rations that good. This limits supply to those who are willing and able to pay for it.
    - - Local markets: In a local marketplace for fruit, if one market stall sells apples for £20 and sells out of 1,000 apples. Then this is a signal for that firm to increase production and sell more apples. It also signals to competitors that they should start selling apples.
      - National markets: If Amazon lists a book at £10, but nobody buys it, then there is a signal that nobody demands that book at £10. Either people don't want the good or they are buying it elsewhere at a lower price. There is an incentive to reduce the quantity produced or to reduce the sale price.
      - Global markets: If the USA can produce steel for £100/ton and sells it for £1,000/ton, this is a signal to nations like China and India that they can make profits by producing steel. They have an incentive to produce steel and enter the market.
    - - The price mechanism shows how demand and supply interact.
      - A change in the price of a good will change the quantity demanded.
      - The price mechanism is free from bias because it is not governed by one human, but lots of different agents interacting.
  - - - The supply line represents the cost of producing a good or service.
      - At the market price, firms who can produce the good or service at or below the market price will supply it to the market.
      - The sum of the extra money earned above the cost of production is the producer surplus.
    - - The demand line represents the value that consumers place on a particular good or service.
      - At the market price each consumer who values the good or service at or above that price will buy and consume it. A number of consumers value the good or service above the market price and gain utility from the good compared to keeping the money they paid for it.
      - The sum of all the extra benefit consumers in a market get from buying and consuming a good or service is the consumer surplus.
    - - Total surplus is the producer surplus plus the consumer surplus. Total surplus is the total benefit to society of economic agents buying and selling a particular good or service.
      - If the market isn't at the market clearing equilibrium there is a deadweight loss. This is because there is an extra possible benefit to society which isn't being generated due to over or under production and consumption.
  - - - If demand was perfectly inelastic, then the demand curve would be vertical.
      - The quantity demanded would not change but the price paid would rise.
      - The burden of the tax would fall completely on the consumer.
      - If demand was perfectly elastic (horizontal demand curve), then the burden would fall completely on the producer.
    - - If demand is elastic, then producers bear the whole burden of an indirect tax.
      - If demand is inelastic, then consumers bear the whole burden of an indirect tax.
- - - - Consumers have needs and wants that people hope will be satisfied.
      - Needs - things people can't live without (e.g. water).
      - Wants - things people can live without but desire (e.g. smartphones).
      - This is achieved by economic activity and the production of goods and services.
    - - There are not enough resources on earth to satisfy humans' unlimited wants and needs.
      - The basic economic problem involves working out how to allocate limited resources as effectively as possible to satisfy people's unlimited wants and needs.
      - Allocating scarce resources
    - - There are scarce resources in society. Because of this, choices have to be made on how to use these resources.
      - The foundation of economic decisions are:
      - What goods/services we produce?
      - How we produce those goods/services?
      - Who we produce those goods/services for?
  - - - Economic agent decision-making
        
        Economic agents make decisions based on their various incentives.
        
        E.g. for firms this might be profit maximisation.
        
        Producers must decide what products to make and the selling price of products.
        
        Consumers decide what products to purchase and how much they want to spend on products.
        
        Governments decide how much they should get involved in the production and consumption process.
    - - Economic agents
      - It's up to economic agents to decide on how to allocate resources.
      - The three main economic agents are:
      - Producers - people/firms that produce goods or supply services.
      - Consumers - people/firms who purchase the goods/services.
      - Governments - establishes rules for economies.
      - Economic activity
    - - Economic activity includes a wide variety of actions, such as:
      - Production of goods (tangible products) and services (intangible products).
      - Consumption of goods/services.
      - Because resources are scarce, we must ask three questions about economic activity.
      - What, how, and who to produce for?
  - - - Positive statements describe the world as it is. They are objective statements that can be proved.
        
        E.g the proposal of the new high speed rail HS2. If the exact benefits exceed the exact costs, you could say the project is worth doing. This positive analysis. However, you may not always know costs & benefits perfectly.
    - - Normative statements describe how the world should be. They are opinions that contain value judgements.
        
        E.g imagine an economist argued for higher unemployment benefits during a recession, because a rich country should take care of its citizens. This is normative analysis.
        
        Value judgments
        
        Value judgments are often found in normative statements. They are judgements about society that cannot be quantified and tested.
        
        E.g the homelessness problem in Oxford needs to be addressed and funds should be redistributed to do this. This judgement is within a normative statement.
        
        Value judgements affect economic decision-making, so normative statements are important.
  - - - Economists rely on the ceteris paribus assumption.
        This means 'everything else remains equal'.
        
        So when economists study the relationship between two factors, they'll assume that one factor changes while the rest stay constant.
        This is the most important assumption for economists to create functioning models
  - - - The PPF shows economy at its maximum productive potential.
      - Society can choose any two goods on or inside the PPF.
      - The opportunity cost is the slope of the PPF.
      - The PPF is curved because of the law of diminishing returns.
      - As you increase units of one resource and keep other factors constant, the marginal benefit from the extra units will eventually start to decline.
    - - The trade-offs occur when producing on the PPF.
      - To produce more of one good, you must produce less of another.
      - For example, if an economy is producing at point A and wants to increase the number of Good X they produce, they must give up producing some of good Y.
      - The PPF shows the economy working at its maximum potential.
      - If there are any points underneath the PPF, this means not all economic resources are being deployed.
    - - The PPF shifts outward if there is economic growth.
      - This is because the productive capacity of the economy has increased.
      - E.g. this could be caused from improvements in technology.
      - But this improvement isn't necessarily equal across all products.
      - E.g. an improvement in the technology to produce cars isn't necessarily going to affect the ability to produce butter.
    - - Point A is a point outside the PPF. It is not currently possible to produce at this point.
      - Point B is a point on the PPF. At this point, all available factors of production are being fully used. All points along the PPF like point B are productively efficient.
      - Point C is inside the PPF. At this point, there are factors of production being underemployed.
  - - - In the late 1700s, Adam Smith proved through example that division of labour could boost productivity in his book The Wealth of Nations.
      - He used the example of a pin factory he visited. He said 10 workers produced 48,000 pins through specialisation. But if each individual carried out every step of production themselves, they'd only make 10-20 each. So the firm avoids employing 2,400-4,800 people through division of labour.
    - - Modern businesses divide their labour force.
      - E.g restaurant operations like Nando's divide up their labour force.
      - There will be a business manager to oversee the process, as well as designated cooks to make the food and sometimes waiters to serve it.
      - If each person does one job a lot, they are usually better at that one job than if they did four different jobs with a quarter of their time.
      - Economies of scale
    - - Specialisation through division of labour allows firms to take advantage of economies of scale. So as production increases, average unit cost decreases.
      - E.g if a BMW factory made 1,000 cars each year, each car would be quite expensive.
      - If they make 50,000 each year, then it can set up an assembly line and cost per unit will decrease.
  - - - This type of market allocates scarce resources based on the price mechanism.
      - The benefits of this:
      - It is efficient - only the highest value products are in demand. So firms are incentivised to produce as efficiently as they can.
      - It rewards entrepreneurship.
      - Consumers have greater choice of products because of the increased levels of innovation.
    - - Inequitable - what is fair in the free market may not necessarily be fair in reality.
      - Missing markets - goods we need in society may not be produced if they cannot generate a profit.
      - Monopolies may arise.
    - - Less efficient - the government is not a profit maximising entity. So the incentive for entrepreneurship and efficiency pushing activities is reduced.
      - Asymmetric information - the government may not actually know what is best because of asymmetric information.
      - Choice restriction.
    - - Government is in charge of resource allocation. North Korea has a command economy.
      - This can correct the inequalities that exist in the free market.
      - There could also be a possible reduction in unemployment.
      - They can break up monopolies.
      - Negatives of command economies
- - - - Everyone in a society learning to get along with one another, mixing at school and having a shared knowledge base should have a positive impact on cohesion in a society.
    - - Economic growth involves using the same inputs to create more or higher quality outputs. This should benefit everyone. In the UK, someone with a median income probably lives better than the Queen 100 years ago.
      - Krueger & Lindahl (2001) find that people receiving better education is associated with faster economic growth.
      - Barro & Sala-i-Martin (1995) completed statistical analysis that found that a 1% rise in spending on education as a % of GDP led to a 0.15% increase in economic growth.
    - - Crime reduces other people's welfare.
      - Moretti's (2001) research found that people with higher levels of education were more likely to vote and less likely to be involved in crime.
  - - - Positive consumption externalities
        
        This is a 'good' externality created in the consumption of a good.
        
        The marginal social benefit is the total benefit of consuming a good or service to society. MSB = MPB + Externality.
        
        If the consumption externality is positive, then the marginal social benefit is more than the marginal private benefit.
        
        Consumers do not account for the benefit of the externality and this good will be under-consumed.
        
        E.g. school education is a positive consumption externality because students become more productive for employers.
      - Negative consumption externalities
        
        This is a 'bad' externality created in the consumption of goods/services (e.g cigarettes).
        
        The marginal social benefit is the total benefit of consuming a good or service to society. It is equal to the marginal private benefit plus the value of the consumption externality.
        
        If the consumption externality is negative, then the marginal social benefit is less than the marginal private benefit and the good will be overconsumed (vs the socially optimal level).
      - Negative production externalities
        
        These are externalities created when producing a good or service.
        
        If the production externality is negative, then the social cost is greater than the private cost and the good will be overproduced (vs the socially optimal level).
        
        E.g a factory producing noise and air pollution is likely to have a social cost larger than the private cost.
      - Positive production externalities
        
        These are externalities incurred when producing a good or service.
        
        Marginal social cost = Marginal private cost - Production externality. MSC is the total cost of producing a good or service to society.
        
        If the production externality is positive, then the social cost is less than the private cost and the good will be underproduced.
  - - - Public vs private goods
        
        Private goods exhibit both excludability and rivalry.
        
        E.g a phone is a private good.
        
        If I purchase a particular phone, that means someone else cannot have that phone (rivalry).
        
        If I do not pay for the phone, I cannot have the benefits of the phone (excludable).
      - Quasi-public goods
        
        A public good can start to have private characteristics and become quasi-public.
        
        E.g putting a tollbooth on a road makes it excludable, and so a quasi-public good.
      - Characteristics of public goods
        
        Non-rivalry: if one person consumes a good this doesn't stop another person from consuming it.
        
        E.g one person gaining benefit from a street lamp doesn't stop another person from gaining benefit from it.
        
        Non-excludable: someone not paying for a good doesn't affect their ability to consume it.
        
        E.g not paying for a streetlamp doesn't mean you can't see when you walk down a street at night.
      - Public goods and market failure
        
        The private sector rarely provides true public goods (as there is little financial incentive to).
        
        The government must intervene and decide the suitable quantity of public goods for society. To do so, the government has to guess the marginal social benefit (which may be inaccurate).
  - - - Market failure is when the price mechanism leads to a misallocation of resources.
      - Resources are misallocated when they are not devoted to the use that will give society the most welfare.
    - - Complete market failure happens where, unless the good or service is provided outside the mechanism, there wouldn't be a market for it.
      - E.g a country's military services.
      - Partial market failure happens when the private sector may partially provide it but at the wrong price or quantity.
      - E.g private healthcare vs NHS.
  - - - Asymmetric information can cause a decline in prices or quantity of products sold.
      - A situation of asymmetric information happens when both parties in a transaction have an unequal amount of information.
    - - Consider Marvin, who is buying a used car from a dealership.
      - The car could either be a 'lemon', which is a defective vehicle, or a high quality vehicle. Because of asymmetric information, Marvin does not know which the car is.
      - This is called a misallocation of resources.
      - This limits his ability to make a rational choice and pay the appropriate price for the car.
- - - - Disadvantages of trade pollution permits
        
        There is a cost to implementing the scheme.
        
        Deciding on the level of pollution is difficult.
        
        The market for permits is subject to failure also.
      - What are permits?
        
        Governments can set an optimal limit on pollution by allocating permits to firms.
        
        These permits can be traded through the price mechanism.
        
        The European Union emissions trading system (ETS) is a way to do this. EU member governments are issued with permits to allocate to firms.
        
        The ETS annually cuts the number of permits. This incentivises firms to reduce emissions because they may be forced to buy more permits for not doing so.
      - benefits of trade pollution permits
        
        This system can put a cap on the level of pollution.
        
        The lower the pollution of a firm, the more they can benefit. This encourages firms to lower their pollution levels.
        
        Governments make revenue.
  - - - Advantages of state provision
        
        State provision can reduce inequality by redistributing money from the wealthy to the poor. This is something the market doesn't always do.
        
        Without state provision, some services might not exist as they aren't profitable.
        
        E.g. some train routes that aren't profitable do not exist.
        
        Value judgements need to be made about what the state can and can't provide well.
      - Disadvantages of state provision
        
        Without a drive for profit, there is less incentive to make a service as efficient as possible. The economic incentives for efficiency could be eroded.
        
        There is an opportunity cost of providing one service over another.
        
        With asymmetric information, there is a risk of government failure.
      - State provision
        
        The government either provides state provisions itself (e.g. state education) or provides free goods or services to the public that it's bought from the private sector (e.g. private health services offered free to NHS patients).
        
        The government pays for goods/services through tax revenues. It then offers them to the public for free.
        
        Examples:
        
        The National Health Service (NHS).
        
        Police service.
        
        Secondary school education.
  - - - Encouraging production/consumption
        
        Subsidies can correct market failure by encouraging the consumption and production of a good with positive externalities.
        
        This is represented on the diagram by a shift to the right in supply, toward a more socially optimal level.
      - Advantages of subsidies
        
        Subsidies can reduce the cost of a product and allow a firm to exploit economies of scale.
        
        This will improve long-run efficiency and competitiveness abroad.
        
        Consumer preferences may change as a result of a subsidy.
      - Disadvantages of subsidies
        
        Subsidies may encourage laziness from producers because they do not need to be as efficient.
        
        There is also an opportunity cost to a subsidy.
        
        Elasticity of demand determines how effective a subsidy is.
        
        Subsidised goods may be of a lower standard than alternatives they're trying to replace.
  - - - Bureaucracy
        
        The private sector has the incentive to maximise profits, but individuals working for governments rarely get the benefits.
        
        Governments are also very large and may suffer from material diseconomies of scale.
      - Inadequate or imperfect information
        
        In a world of perfect information, governments should be able to make the right decisions to improve allocation.
        
        Asymmetric information limits the governments ability to critically assess market failures and possible solutions.
        
        So the right decision isn't always made and government failure can arise.
      - Administrative costs
        
        Resources are needed to implement government intervention.
        
        If the cost is too high, the intervention may not be worthwhile.
        
        Daniel Kahneman's inside view explains why governments may frequently underestimate the cost of their projects. The Scottish parliament in Holyrood was forecast to cost £10-40M but cost £414M.
      - Misallocation of resources
        
        Government failure is the result of a policy trying to correct a market failure that has led to a misallocation of resources.
        
        This means there is a welfare loss to society.
        
        E.g the council might charge people for some forms of waste disposal.
        
        This may increase fly-tipping, which is a worsening of the initial pollution externality.
  - - - Irrationality
        
        The UK government has a Nudge unit, which implies that consumers may not be rational agents and need guidance.
      - Overconsuming demerit goods
        
        Demerit goods like cigarettes may be overconsumed.
        
        Taxes or bans may be interventions to solve this issue.
      - Underconsuming merit goods
        
        Governments may want people to consume more things like education, which have positive externalities.
        
        Subsidies or free state provision may be used to encourage the consumption of merit goods.
      - Meeting basic needs
        
        In a market-based economy, a consumer's ability to consume goods and services depends on their income and wealth.
        
        If a consumer has a low income, they may not be able to afford basic goods to satisfy their needs.
        
        The market is under-providing these goods and this can be a source of market failure.