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AS and A Level: Markets & Managing the Economy
Meet our team of inspirational teachers
How do markets work?
- 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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’.
Low exit barriers can be characterised by low sunk costs: those initial costs that cannot be recouped by firms upon exiting the market. For example, the air travel market may be deemed not to be contestable as it has relatively high sunk costs; firms must train pilots etc. These low barriers encourage ?hit and run? entry into a market. This is where a firm is achieving an abnormal profit in a contestable market, which is a motive for others to join the market.
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Discuss the extent to which a tax on chewing gum is the most appropriate way of solving the market failure involved?
It costs 10p to remove every piece of gum, and therefore can become very expensive. By the government introducing an indirect tax on non-degradable chewing gum, it hopes that consumers will become aware of the now more expensive non-degradable gum and turn to the cheaper more environmentally friendly, biodegradable gum. Therefore, less permanent gum will be dropped onto the streets and subsequently costs on local councils will be reduced. However, by implementing these taxes on chewing gum, the government may become unpopular within the public from the increased price and therefore will become less likely to implement taxes and policies to better improve the environment and public areas, in the future.
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Using the data and your economic knowledge, evaluate the economic case for and against government intervention in car markets.
It is part of the way that markets work to allocate resources that the excess supply created should put downward pressure on price, reducing the price of cars relative to other goods, and also reducing the profit margin on each car supplied for a given cost of production. This incentivises producers to cut back on car production, with resultant job losses in the industry. I It is also a knock-on effect that prices of used cars, a substitute for new cars, should fall during such a period.
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Another important concept concerning the people is economic equity; people greatly value equality. Treating people fairly without discriminating between them is an important rule. Thus, discriminating on the basis of age, s*x, race, religion, or disability is illegal. An example for economic equity would be minimal wage; the lowest legal wage that can be paid to a worker. People who are not very rich get affected dramatically by inflation; therefore, people prefer to have price stability. Price stability is important because inflation can damage a lot of business and people, discouraging them to get in business and this lead the people to poverty and hating the government and doing riots and strikes.
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One choice will be the ?best? one and a rational economic agent will take that alternative. But all the other choices will then have to be given up. Neither people?s wants nor their ability to produce goods and services are constant. Their productive potential is increasing all the time, but so their appetite for material things. As a result, scarcity will always exist. Given that human wants exceed what can actually be produced, potential demands will exceed potential supplies. For that reason, scarcity forces economic decision makers (individuals, families, firms, and governments)
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which requires huge amount of data and an ability to forecast the future. In market economy prices provide signals to buyers and sellers in turn influence prices. Motivation is pure self-interest in free market economy which means decisions are based on private gain. Consumers want to maximise utility, producers want to maximise factor incomes while in planned economy there is a lack of choice for consumers in terms of what goods are produced.
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This makes for a more accurate rate of GDP. E.g. I have £1 million pounds in 2012 but because of an inflation in 2008 which was the base year, I could have a value of much less money. The real GDP could go down to £750,000. Real GDP includes changes in inflation whereas normal GDP does not. Aggregate Demand is affected by the total sum of consumer goods and services (consumption and spending costs), our total spending in the economy e.g.
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Relative poverty is suffered by a household if its income is below a specified proportion of average income for all households. Relative poverty defines ?poverty? as being below a relative poverty threshold. It classifies individuals or families as ?poor? not by comparing them to a fixed cut-off point, but by comparing them to others in the population under study. When all incomes grow, absolute poverty falls, however, relative poverty only falls if low incomes grow at a faster rate than average incomes.
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There are several measures Singapore can take to reduce inflation: fiscal policy, exchange rate policy and supply policies, both short term and long term. The exchange rate policy can be used to reduce inflation in Singapore. Exchange rate policy is a policy that is used to control the exchange rate to influence aggregate demand or aggregate supply. When its external economic environment is strong, Singapore will experience high inflation in the absence of central bank intervention.
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Value added is the difference between the sales revenue received and the actual cost. The income measure is based on the costs involved in producing the output. The income received by all factors of production are added up, these include wages, rent, interest and profits. It is important to only include payments received in return for providing the good or service. Lastly, the expenditure method is basically a summing up of C + I + G + (X-M). C is the consumption expenditure, I is investment, G is government spending and X-M is the net exports.
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QUANTITY 340 580 380 500 The new equilibrium price is £300 The new equilibrium quantity is 640. Factors that may have caused and increase in the demand of tables are because the quantity was increased by 180 at the same price. This can activate an increase of sales of the tables because the demand is more as more tables are available at the same price, based on an improved quantity of 180 tables. As consumers’ income is higher, there is more demand at each price level. This may have happened if interest rates had fallen and more credit was available, so more income was available to consumers to buy tables.
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In an competitive market where money is used, the price will reflect what the suppliers wish to sell their products for and this will indicate the price that buyers will be willing to spend to consume a product. Prices fluctuate due to the effective demand of a consumer- the willingness and ability to purchase a product- and also due to the supply of a product. For example, a sudden drop in supply (shortage) for a product will cause the price to increase and a sudden increase in a demand for a product in a competitive market will also cause the price to increase.
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For the Broadcasting market discusses the extent to which it is contestable in terms of its characteristics and its consequences.
Competition is set to increase significantly with the arrival of digital TV, allowing greater programs to be aired for free. Greater competition will allow improving content as broadcasters battle to keep their viewers. Technological advances in innovation may promote a greater scope of competition in this market. BskyB is holding a monopoly in major sports which have a significant barrier to entry for a new broadcaster or even an existing broadcast sports like that of SKY. This results in a barrier to entry from high capital investment.
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Discuss the view that government policies aimed at reducing wage differentials always do more harm than good. [20 marks]
Similarly individuals who own assets eg: homes and cars and so on. The value of theses depends on supply and demand as well. One way the government can reduce wage diffentials is by setting a minimum wage. A minimum wage will help those who?s bargaining power is weak, therefore individuals will have sufficient income to pay bills and have a fairly good standard of living.
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Using the data and your economic knowledge, evaluate the view that the benefits resulting from a more equal distribution of income exceed the costs.
as they could get paid the same amount for doing an easier job (e.g. window cleaning). The graph shows the inequalities in the wage rate that would be removed but there would be a cost of implementing the more equal distribution of it.
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In recent years, British Telecom, the supermarket industry and 50 private schools have been investigated by the competition authorities for limiting competition. Evaluate different ways in which governments could make markets more competitive.
An example of when this was used is when BT was privatised by the government, OFTEL forced BT to allow other companies to use its network. This made prices more competitive as it meant that they had to fight for customers with other companies. The government may also want to make the industries in question more quality competitive by encouraging more to be spent on research, development and design.
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This laissez-faire system allows entrepreneurs the freedom to buy what they want and sell what they want, to whoever they want. This system also allows the consumer to spend their money however they please without having to worry about paying any such taxes as there are state owned services. This is possibly the most important aspect of the market economy as it allows the producer to determine what the consumer really wants by listening to their demands and then deciding how they use their economic resources to meet these demands.
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However, there are a lot of problems which are caused by looking at these datas. The main problem with GDP is that we always have recessions and recoveries throughout the period. However, if we forecast mainly on these figures, the chances that we will be wrong are really high. For example, in 2008 no one expected to have crisis and a lot of transport projects were rejected to be brought in reality as economics estimated that there will be a huge increase in GDP and the economy would flourish, as a result they were wrong and current needs did not meet transport planners? plans.
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The tobacco industry maintains that cigarette advertising does not increase the incidence of smoking. If this is so, why do firms engage in advertising? Should tobacco advertising be banned?
By referring to figure 1 and 2, if firm 1 advertises, firm 2 cannot obtain a higher pay-off if it chooses not to advertise be it either the collusion or non-collusion case. Such a Nash equilibrium is self-enforcing whereby no firms want to deviate by choosing another strategy. In both these cases, there is a dominant strategy equilibrium whereby the best move for a firm regardless of what another firm does would be to advertise. Figure 1 (collusion pay-offs) Do not advertise Advertise Do not advertise 2,2 3,4 Advertise 4,3 5,5 Figure 2 (Non-collusion pay-offs)
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Most people are not willing to give up their morning cup of caffeine no matter what the price. Therefore, the caffeine is an inelastic product because of its lack of substitutes. Thus, while a product within an industry is elastic due to the availability of substitutes, the industry itself tends to be inelastic. Usually, unique goods such as diamonds are inelastic because they have few if any substitutes. Another factor is the amount of income available to spend on the good.
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Discuss the effect on the behaviour of firms in spectator sports when profit maximisation is not their primary objective
These clubs are backed by wealthy owners. Profit maximisation of player sales is not required; owners are more willing to peruse to improve the success of the club, this includes beating rivals, winning cups and leagues in the future. Number of owners of UK sports clubs especially within football, which don?t see their club as a business, owner of football club may see that success on the pitch may be in turn paying for more talented players and increasing their wage, making the connection of the mangers role of the club down to performance rather than profits earn.
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Given the degree of government interference in market economies and the increased economic freedom in command economies, do you think the two types of economic systems will converge into one?
Most communist countries have had command economies; capitalist countries may also adopt such a system during national emergencies in order to mobilize resources quickly. Command economy, also called planned economy, discourages individualistic profit motives and consumerist needs. Absence of profit motives precludes any need for competitiveness. This acts as a disincentive in individual contribution to collective efforts. In the 20th century, the former Soviet Union was an example of command economy. Today, countries using command economy include Cuba and North Korea.
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Because a command economy is fully controlled by the government, it is less subject to inflation and downturn than other types of economies. Other than that, command economies can also more equally distribute wages, bonuses, materials and services rather than focusing on the wealth and opportunity of select individuals. When a command economy is used to benefit citizens equally and to provide necessary resources to all, it can increase morale among citizens. Because this type of economy is planned out by governmental agencies, it can take into account the resources available and attempt to utilize them to their fullest potential.
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A change in price would result in a big change in demand which can be seen in figure 1.2. Figure 1.1 Figure 1.2 The reason why could be found if looked at the non-price determinants of elasticity. Those are: the substitution effect, the income effect, the degree of necessity, the addictive nature of the product, the number of uses of the product and the time period covered. I will use wheat as an example of a primary commodity. Generally, wheat only has a few close substitutes. The less substitutes for a product, the more inelastic it becomes as there is less choice for the purchaser.
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as the rich get richer and the poor get poorer. This last point is disputable as some people argue that economic growth benefits everyone as goods get cheaper as firms expand and markets become more crowded, thus helping the poor to survive. They also say that as firms expand to handle the new consumption that it provides employment for the poor. But some oppose this and claim that as firms expand, the educated get employed and the firm replaces the un-skilled worker with new machinery they can invest it, thus reducing the amount of employment for unskilled workers and therefore reducing economic welfare.
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