Economics Competitive Markets and How They Work essay (50)

What is a ‘Competitive Market’?

  • The market economy tries to resolve the economic problem via demand and supply, through the price mechanism
  • But how do markets work? And how does it allocate scarce resources in relation to our infinite wants

  • There are many examples of markets, but each has the same basic characteristics:
  • A willingness to trade or exchange goods and services. This is usually done using money, but bartering may be used in a developing country
  • A physical place where buyers and sellers can meet or contact each other.

  • Markets are also competitive
  • This is because they provide for the resolution of the basic economic problem, whereby scarce resources are allocated via the price system.
  • In every market where money is used, the products that are bought and sold command a price
  • This reflects what suppliers wish to sell their product for and what consumers are willing to pay to consume it.
  • The interaction of buyers and sellers determines the price of a product in any market situation.

  • The fact that markets are competitive means that prices fluctuate
  • So if more producers put more of their products on the market, the most likely result is that prices will fall.
  • The same thing will happen if buyers hold back from purchasing a product
  • In contrast, if producers restrict what they are willing to sell, then prices will increase, as well as a sudden surge in demand from consumers

  • Markets may be relatively complex to describe
  • Big markets can be split up into sub markets, and those submarkets split up further
  • The same general principles for the operation of markets apply in all cases.


  • Demand is what consumers want
  • However, what consumers want and what they demand are not the same thing for two reasons
  • Wants are unlimited. We would always like to consume more or consume things we aspire to e.g. Rolex watches
  • Demand is that to consume a product, customers must have the ability to pay.
  • They must be able to afford what they demand
  • The distinction can be made clear between wants and demand with the introduction of the terms notional and effective demand. The former being like wants.

  • The definition of demand – effective demand – assumes that all other factors that affect the demand of the product don’t change
  • I.e. any changes in the quantity demanded are due to the price of the product alone.
  • This is referred to as ceteris paribus
  • As defined, the quantity demanded must be time related in the sense that it needs to be specified over a day, week, etc.
  • If sales for holidays were for a given week, then the quantity demanded would clearly be lower than for annual sales.

Relationship Between price and Quantity Demanded

  • From prior experience, we know that if the price of something falls, we want it more
  • Similarly, in a supermarket, a price reduction in a product we normally buy will result in an increase in the quantity demanded
  • So as price increases, demand decreases
  • This is an inverse relationship
  • In considering matters of demand and price, we assume consumers are rational, and if products are exactly the same, they will opt for the cheaper on.

The Demand Curve

  • The demand curve shows the relationship between the price of a product and the quantity demanded
  • Price is plotted on the y-axis, demand on the x-axis.
  • The data from which a demand curve is derived is the demand schedule
  • The data for a demand schedule can be gained from past records and questionnaires, where customers are asked on issues like price.

  • Notable points:
  • Notable Points
  • Normal Inverse relationship
  • Linear relationship
  • Relationship only applies to holidays in June
  • Can extrapolate data:
  • At £325, 900 holidays will be demanded

  • Demand curves can also represent the demands of an individual.
  • When representing just an individual, the curve may be curvilinear

Consumer Surplus

  • In almost every market situation, there will always be some individuals who are willing to pay above what they actually have to pay to satisfy their demand
  • However, consumers pay the price offered, and no the price that they’re willing to pay, and so potentially save some money.
  • This is known as consumer surplus
  • For the cinema trip scenario, the consumer would be willing to pay £4 for the first cinema trip, but the actual price of tickets is £1.50
  • This means that the consumer receives a surplus of £2.50 (£4 - £1.50)
  • When the demand is 5 trips per moth, the consumer will receive a surplus of £5.05 ((£4 - £1.50) + (£3 - £1.50) + ... etc...)

Calculation of Total Expenditure and Total Revenue

  • Data which is drawn from a demand curve can be used to calculate the total expenditure made by the consumer
  • In turn, this is the total revenue or sales of the producer
  • Total Expenditure = (price x quantity demanded)

  • If we take another look at the ‘holidays in Ibiza’ market demand curve, we can see at a price of £300, 1000 holidays will be demanded
  • Total expenditure by those consumers is (300 x 1000) = 300,000
  • If the price rises to £325, then 900 holidays are demanded
  • This means that the total revenue of the tour operator is (900 x 325) = £292,500

Other Factors Affecting Demand

  • Obviously, it is clear that price has a major effect on the quantity of a product that is demanded
  • Price, however, is not the only reason or factor that affect demand
  • Three non-price factors that influence the demand for a product are
  • Consumer Income
  • The prices of other products
  • Tastes and Fashion

Consumer Income

  • Income obviously has an important influence on whether or not we actually buy a good
  • If something is outside the price we are willing to pay, then there will be no effective demand for it

  • To be more specific, it is best to look at income in terms of what is left over once tax has been deducted, state benefits are added and the effects of inflation have been taken into account
  • This is called real disposable income
  • For most young people, disposable income is the allowance that is given after deductions are made
  • The ‘real’ element changes the meaning
  • For example, if the money you receive increases by 5% over a period of time, but prices rise by 3%, then ‘real’ income has increase by just 2% (5% - 3%)
  • If the rise in prices has risen more than the rise in income, then ‘real’ income has actually fallen

  • With the aforementioned in mind, the demand for a product will increase as consumers’ income increases
  • With more income, consumers have greater spending power, and so buy more of most goods and services
  • This is true for most goods, such as cars, TVs, holidays, cinema trips, and so on
  • These products are known as normal goods

  • In some cases, the relationship between income and demand is inverse
  • As income rises, demand for the product fall
  • These are known as inferior goods
  • This doesn’t mean that these products are of inferior quality
  • They are products that are consumed only because more desirable alternative cannot be purchased with available income
  • So as income increases, a better alternative can be purchased

  • It is difficult to generalise about inferior goods
  • What is inferior to one person may be normal to another
  • This all depends on a consumer’s income
  • Some consumers may regard a holiday to Benidorm as inferior.
  • Other people, who have not been able to afford a holiday, will include such a trip as a normal good
  • Despite the subjectiveness, products such as supermarket own label goods (compared to recognised brands) can be regarded as inferior goods
  • The final outcome is determined by what happens to the total demand for a product following a change in income, not one individual’s demand.
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The Prices of Other Products

  • The demand for a product can also be affected by a change in the price of another, different product
  • Two possible cases are recognised
  • These are where there are substitutes and complements to the product in question

  • Most products have substitutes.
  • They occur when a good or product faces competition from another product
  • In such situations, there is competitive demand

  • To the economist, there is a relationship between the price of one product and the demand for a substitute
  • If the price of a product goes up, then ...

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