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Markets and Price Determination

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Introduction

Economics Markets and Price Determination Definition of a market Market = A mechanism which brings together buyers and sellers for the purpose of exchanging goods and services The market determines: * the price at which the good is traded * the quantity of the good that is traded at this price. Markets come in many shapes and sizes, and can include: * Shops * Newspapers (e.g. Exchange and Mart) * Internet * Telephone lines * Cards in the newsagent's window * Jumble sales * Car boot sales Markets for goods can be: * local (e.g. Blackpool rock) * national (e.g. The Times newspaper) * International (e.g. crude oil). Markets can be: * Formal - meet in a specific place, at a specific time, with only qualified traders being admitted (e.g. markets in shares, foreign currency and commodities like oil). * Informal - meet irregularly, with anybody allowed in to trade (e.g. car boot sale). Markets can be: * Competitive - many buyers and sellers (e.g. vegetable market) * Monopoly - only one seller and many buyers (e.g. postal service market). Any market, no matter what its size or shape contains two groups, each exerting a market force that helps to determine the good's price and quantity traded: * Buyers exert the market force of demand. * Sellers exert the market force of supply. Demand Demand = A consumer demands a good if he wants it, and is willing and able to pay for it. Wants are unlimited, but demand is limited by factors like the good's price and the consumer's income, which restrict his ability to purchase it. Factors affecting the demand for a product 1. The price of the product Law of demand = 'all other things being equal, if the price of the good increases, the quantity demanded falls, and if its price decreases, the quantity demanded rises.' Utility = the amount of satisfaction obtained from consuming a product. ...read more.

Middle

Supply of seasonal goods falls out of season. Natural factors (e.g. weather, earthquake) Perfect weather can boost the supply of crops. Floods, earthquakes, hurricanes, etc can decrease supply of goods temporarily or permanently. Man-made factors (e.g. strike, war) End of a strike or of a war will boost supply. A strike, fire, theft or outbreak of war will reduce supply. The Determination of Price Equilibrium point = the point at which quantity demanded is exactly equal to quantity supplied, and where the market price will be established. Market equilibrium = Point where the D and S curves intersect = Point E. Equilibrium price = Price at the market equilibrium = p. Equilibrium sales = Sales level at the market equilibrium = q. At price p, consumers buy q goods and maximise their utility, while producers sell q goods and maximise their profits. Any attempt to charge a price other than p will lead to a disequilibrium situation and will activate market forces that will return the market to equilibrium. At price p1, demand for goods will only be q1 while supply will be q2. Hence there is an excess supply of goods (also known as a 'glut') causing price to fall back to p (a buyers' market). At price p2, demand for goods will be q3 while supply will only be q4. Hence there is an excess demand for goods (also known as a 'shortage') causing price to rise back to p (a sellers' market). Causes of Price Changes The only way that the price of a good can change, unless the government is price fixing, is for the market equilibrium to move to a new position. This will occur if conditions in the market alter, leading to a shift in either the demand or supply curve. There are four possibilities, two for a price rise and two for a price fall. A price rise (i) ...read more.

Conclusion

20 �100 Price elasticity of supply Price elasticity of supply = The responsiveness of the supply of a good to a given change in its price. It is calculated using the formula: price elasticity of = % change in quantity supplied supply (PES) % change in price Elastic supply = quantity supplied of a good is sensitive to a change in its price. PES > 1 Inelastic supply = quantity supplied of a good is insensitive to a change in its price. PES < 1 Unit elastic demand = quantity supplied of a good changes by an equal percentage to the change in its price. PES = 1 The slope of the supply curve will reflect the good's price elasticity of supply. S1 = perfectly inelastic supply (PES = 0) S2 = inelastic supply (PES < 1) S3 = unit elastic supply (PES = 1) S4 = elastic supply (PES > 1) S5 = perfectly elastic supply (PES = ?) Factors determining a good's price elasticity of supply * Time - when the price of a good changes, its supplier has to adjust production, but this cannot be done quickly because the factors of production have to be hired or fired. Supply is less elastic in the short run than in the long run. * The availability of excess capacity or stocks - if a supplier is not working at full capacity, there is slack in the production system, which will enable supply to react more quickly to a price change and hence be more elastic. The same is true if a producer is carrying stocks of unsold goods. * The availability of factors of production - if the price of a good rises and the supplier wishes to extend output, more factors of production will be needed. If these are easy to obtain, supply will be more elastic. Factors of production will be available if there is a recession, with high unemployment and plenty of empty (closed down) shops on the high street. ...read more.

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