What is a market? Buying and selling is fundamental. A market is any situation or place that enables the buying and selling of goods and services and factors of production. A market may be a physical location (a street market), it may also be a virtual one (internet buying and selling) or a national one (the market for teachers or doctors). Triple A Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce good and services. 13
The Supply & Demand Model 14 The intersection of demand and supply is the goal that every seller want to achieve.
Demand Higher the price less people would buy. A schedule (curve) that shows the quantity of a good that consumers are able and willing to buy at a certain price during a specified period of time. 15
Change in Quantity Demanded Movement along the demand curve 16
Price Support/Buffer Stock Schemes Governments intervene when there are extreme price fluctuations brought about by seasons factors (agricultural products) and/or economic factors (commodities). 50
Price Lost Consumer Surplus New Consumer Surplus Lost Producer Surplus New Producer Surplus Quantity Loss in Efficiency Too High a Price (Price Floor) S PH Price Floor Po D Qo QL
Price Lost Consumer Surplus New Consumer Surplus Lost Producer Surplus New Producer Surplus Quantity Loss in Efficiency Too Low a Price (Price Ceiling) S Po PL Price Ceiling D Qo QL
Commodity Price Agreements A buffer stock scheme involving several countries E.g UNCTAD OPEC 53
Elasticities How sensitive is a buyer to a change in price? How sensitive is a buyer when another product changes price? How sensitive is a buyer to changes in their own income? How sensitive is a supplier to a change in price? 55
Practical Implications of Elasticity Impact on Total Revenue of Firms Tax Incidence 73
Impact on Total Revenue of Firms Total revenue is the amount paid by buyers and received by sellers of a good. TR = P x Q With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases. With an elastic demand curve, an increase in price leads to a increase in quantity that is proportionately smaller. Thus, total revenue decreases.
Taxation Governments levy taxes to raise revenue for public projects Critics of taxation argue that: Taxes discourage market activity. When a good or service is taxed, the quantity sold is smaller.
Summary The incidence of a tax refers to who bears the burden of a tax. The incidence of a tax does not depend on whether the tax is levied on buyers or sellers. The incidence of the tax depends on the price elasticities of supply and demand. The burden tends to fall on the side of the market that is less elastic.
Typical Examination Question Questions on the Theory of Demand and Supply Explain the function of prices. Explain the function of markets. The basic economic problems is scarcity. Explain how a market economy (or command economy) allocates resources. Evaluate the consequences of price controls. Evaluate the view that it is best to allow primary commodity prices to be determined purely through the free interaction of market forces. 117
Typical Examination Question Questions on Elasticity Define cross elasticity of demand (or the other elasticities ) and using diagrams, explain its impact. Explain why price elasticity of demand and the price elasticity of supply tends to be low on primary commodities and how this impacts price stability.
Typical Examination Question Questions on Market Failure Explain the differences between merit goods, demerit goods and public goods. Evaluate the view that governments should always intervene in markets for such goods as cigarettes and alcohol. With the aid of a diagram, explain how the application of a flat rate tax (a specific/fixed amount) could reduce pollution. Using an appropriate diagram, explain how negative externalities (or positive externality) are a type of market failure. Evaluate the measures that a government might adapt to correct market failure arising from negative (or positive) externalities. 119
Resources Phil Holden has an excellent set of youtube videos on all aspects of markets. Teaching Tools for Microeconomics from John Stosel is a little dated but still another excellent source of video clips on markets. This is produced by ABC News. Paul Solman has produced a series of video clips designed to accompany Economics by Paul Samuelson. They are excellent for the IB Course. The DVD can be obtained from McGraw-Hill. The National Council on Economic Education has produced a two volumes of student activities: Advanced Placement Economics: Microeconomics Student Activities Workbook, 3rd Edition, and Advanced Placement Economics: Macroeconomics Student Activities Workbook, 3rd Edition. Though they are designed for Advanced Placement students many of the data sets helps IB students understand key concepts. These activities are especially good for students who are more mathematically minded. 120