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AS and A Level: Markets & Managing the Economy

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How do markets work?

  1. 1 Economics is the study of the allocation of resources so understanding how prices are set and the amount of resources used for any particular product is important.
  2. 2 Most resources are allocated by the free market. Adam Smith called this ‘the invisible hand’ as no one is in charge of it. It just happens through the interaction of millions of individual buyers and sellers, all working in their own best interest.
  3. 3 The price and amount produced are determined where the amount supplied equals the amount demanded. This is known as market equilibrium or the market clearing output.
  4. 4 Any changes to the supply of a good e.g. costs change, weather disrupts production or any change in demand e.g. a product goes into or out of fashion will cause a change in the equilibrium point and so lead to a change in price and output.
  5. 5 When discussing this, always start with the change in supply and demand and talk about the change to price and output this causes. Not the other way round.

What is market failure?

  1. 1 Markets do not work perfectly all the time. Several things can and do go wrong with its operation. One of these is market power. If individuals or groups of producers (or consumers to a lesser extent) have too much power, they can distort the market.
  2. 2 Externalities – The production and consumption of many goods has an external cost e.g. pollution that is paid by other people than those who consume or produce the product. To determine how much of this product should actually be produced or consumed for the greatest benefit to society, this cost should be taken into account as well.
  3. 3 Public goods – Some goods would not be produced at all by the free market as it is impossible to stop other people benefiting from them (the free rider problem). Examples include defence, light houses and street lights.
  4. 4 Merit goods – Some goods would be under-consumed if it was left to individuals to decide how much they wanted to spend on them. This is because they have external benefits to society beyond the private benefits e.g. we all benefit from an educated workforce.
  5. 5 Make sure you are comfortable with the market failure graphs and some of the other reasons for market failure e.g. information problems, immobility of the factors of production.

Five key facts about price elasticity of demand

  1. 1 Elasticity matters because it determines the importance of shifts in the demand and supply curves and helps with our understanding of how markets operate. In theory all demand and supply curves have different elasticises at different points along them. We are interested at their elasticity where they intersect.
  2. 2 Price elasticity of demand measures the responsiveness of demand to a change in price. The formula is the percentage change in quantity demanded divided by the percentage change in price.
  3. 3 Demand for a product is elastic if the percentage change in demand is greater then the percentage change in price e.g. a 10% price rise causes a 20% reduction in demand.
  4. 4 Demand for a product is inelastic if the percentage change in demand is less than the percentage change in price e.g. a 10% price rise causes a 5% reduction in demand.
  5. 5 Remember the formulae for income and cross elasticity of demand and price elasticity of supply. Q always goes on the top in the formula. We always ‘queue up’.

  • Marked by Teachers essays 10
  • Peer Reviewed essays 11
  1. Marked by a teacher

    Explain how the equilibrium level of output is determined in perfect competition. Both for the whole market and one firm within the market

    4 star(s)

    There is also perfect information for the consumers and producers. Most importantly, in a perfectly competitive market, the firms aim to maximize profits, firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit. Following on from above, an important idea from which equilibrium output is determined in perfect competition is that the firms main aims are to maximize profits. So, price taking from the firms guarantees, that when the firms maximize profits, by choosing the quantity they wish to produce and the combination of factors of production to produce it with, the market price will be equal to marginal cost.

    • Word count: 1303
  2. Marked by a teacher

    Comment on the statement that only carbon trading is likely to be an effective and efficient way of reducing C02 emissions.

    3 star(s)

    "Developing countries would face a lower burden in reducing emissions than developed countries". This is because developed countries have more industries such as steal which require huge amounts of carbon to be exerted into the atmosphere, whereas developing countries won't have many of these industries and it will be easy for them to stay below their quota and may then even be able to sell their permits to more developed countries on the open market. You will also need tight limits on regulations, we need huge transfers of wealth to poorer countries to be effective as these countries may not be able to afford the permits if they end up going over their limit.

    • Word count: 1003
  3. Marked by a teacher

    Essay: Discuss whether the Basic Economic Problem will ever be solved

    3 star(s)

    can use coal instead, where there are huge amounts of reserves all around the world and it would be available for a lot less than the price of oil. There is a question, if the northern countries in the world can survive without oil, as they themselves have little reserves, therefore are having to import it from other places in the world for huge prices, which reflects the price consumers have to pay for it, this is why countries' governments have to look for alternatives such as coal, nuclear power and renewable energy.

    • Word count: 1175
  4. Peer reviewed

    Is the existence of a monopoly against The public interest?

    5 star(s)

    In this market structure it is also assumed profits are maximised and there is consumer rationality. Traditionally monopoly is thought to be a potentially harmful market structure with unwelcome consequences for the consumer and the economy. Competition has always therefore been seen to be desirable. It could be said therefore to be against the public interest. However there are arguments not only against monopolies but also for their existence. One of the main arguments against monopolies is that they raise prices, restrict output and therefore exploit consumers.

    • Word count: 1068
  5. Peer reviewed

    Outline the argument for and against smoking ban

    4 star(s)

    So they want people to consume where the pink lines meets the green line. MSB = MSC (5 a day). Below 5 a day both the MSC and MPC are below MPB and MSB. So both society and the individual wants to consume the good. Above 10 a day the MSC and the MPC are above the MSB and the MPB so neither the individual or society wants more than 10 cigarettes a day. However in between 5 and 10 cigarettes a day, the MSC is above the MSB so society does not want to have that many cigarettes.

    • Word count: 1026

Conclusion analysis

Good conclusions usually refer back to the question or title and address it directly - for example by using key words from the title.
How well do you think these conclusions address the title or question? Answering these questions should help you find out.

  1. Do they use key words from the title or question?
  2. Do they answer the question directly?
  3. Can you work out the question or title just by reading the conclusion?
  • "Discuss and evaluate the proposition that perfect competition is a more efficient market structure than monopoly."

    "Consequently the statement of perfect competition being more efficient than monopoly is not entirely true. In conclusion, although perfect competition is more economically and productively efficient than monopoly, monopolies have dynamical advantages. Monopolies can exploit economies of scale and economies of scopes which in theory would lower cost. Also perfect competition doesn't include externalities in which case it wouldn't be efficient. Even though it is almost impossible to have a pure monopoly or a pure perfect competition market structure in an economy, perfect competition seems to have an advantage regarding static efficiency over monopoly. The question now is whether a perfect competition market model is more desirable over a monopoly market model. Economics Essay By: Santiago Caicedo 10-5 Topic: Perfect competition and Monopoly. Research question: "Discuss and evaluate the proposition that perfect competition is a more efficient market structure than monopoly". 1 ROY J. RUFFIN, PAUL R. GREGORY, "Principles of Economics" Chapter 30 pg.563 Fifth Edition 2 ROY J. RUFFIN, PAUL R. GREGORY, "Principles of Economics" Chapter 30 pg.566 Fifth Edition 3 ROY J. RUFFIN, PAUL R. GREGORY, "Principles of Economics" Chapter 30 pg.610 Fifth Edition 4 ANNE KRUEGER, "The Political Economy of the Rent-Seeking Society." American Economic Review 64 (June 1974). 5 HARVEY LEIBENSTEIN, "Allocative Efficiency vs X-Inefficiency", American Economic Review56(June 1966)"

  • Discuss the view that monopoly power is always negative from a consumer and economic view point.

    "Overall, there are many negative impacts of monopoly power; however, there are also benefits, both to the consumer and from an economic view. We can definitely reach the conclusion that monopoly power is not always negative as there are advantages. However, overall, the disadvantages do overpower the advantages of monopoly power when considering the view economically or form the consumers' view"

  • What are the implications for economic welfare of a market structure changing from perfect competition to a monopoly charging a single price? To what extent would you modify your conclusion if the monopoly practiced price discrimination?

    "In conclusion, perfect competition results in allocative and productive efficiency. When market structure changing from perfect competition to monopoly charging a single price, there is a deadweight loss to the society. The resources are not used efficiently. Meanwhile, there is redistribution from consumers to the monopoly producer. Moreover, the monopoly leads productive inefficiency because of lack of pressure. But on the other hand, monopoly has the incentive to innovation. It may benefit from the economies of scale. From these standpoints, monopoly is more efficient than we thought. If monopoly practices price discrimination, the economic welfare will increase up to the total surplus in the perfect competition. The price discrimination increases the efficiency of monopoly. "The more perfectly the monopoly can price discriminate, the closer its output gets to the competitive output and the more efficient is the outcome." (Economics, fifth edition, Michael P) However, there is a transfer of surplus from consumer to producer."

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