M A R K E T A N A LY S I S : D E M A N D A N D S U P P LY 55

2.5.1 CHANGES IN EQUILIBRIUM

Market analysis based on demand and supply can be used to consider the effects of
changing circumstances on equilibrium.

Staying with the car market, city councils in both London and Paris were
considering banning SUVs due to their environmental impacts; they are big,
relatively more dangerous to pedestrians and other motorists in crashes, and
they generally have higher emissions than cars.

Figure 2.6A shows a possible scenario for the international car market, should a ban
be imposed. D1 indicates initial demand for cars before the outlawing of SUVs, when
P1 was the equilibrium price and Q1 represents equilibrium quantity. D2 shows the
increase in demand for cars indicating that changes in regulation affecting the use
of goods change demand. With no change to supply, the effect of the rightward
shift of the demand curve is a new equilibrium at P2 and Q2. Increased demand
leads to both a higher price and quantity in equilibrium.
If such bans become commonplace internationally, many SUV producers might
switch their production to more standard cars as their equipment and factories
could be adapted without too much difficulty. Should this lead to substantial new
entrants into the market, Figure 2.6B indicates a possible outcome. Supply expands
from S1 to S2 giving rise to another new equilibrium position. Focusing on D2 and
S2 as the relevant demand and supply curves, P3 and Q3 represent the equilibrium
position where price falls relative to P2 and where quantity expands to Q3.

A B
Price Price
D1 D2 S D1 D2 S1
S2
P2 P2
P3
P1

Q1 Q2 Quantity Q2 Q3 Quantity

FIGURE 2.6 POSSIBLE SCENARIOS FOR THE CAR MARKET

56 THE ECONOMIC SYSTEM

2.6 GOVERNMENT AFFECTING PRICES

Attempts are sometimes made by government to influence the price in a particular
market. Examples are price ceilings and price floors, which are cases when the
actual market price is not the same as the equilibrium price.

2.6.1 PRICE CEILING

A price ceiling or price cap is a price that puts an upper limit on the price that
suppliers can charge.

The purpose of a price ceiling is to allow consumers to buy products at relatively

low prices.

In January 2002 the Filipino government implemented a price ceiling on

utility vehicles in an attempt to reform taxes in that industry. The price ceiling
applied to basic models only and meant they were tax exempt.

The general effects of a price ceiling are shown in Figure 2.7 for the case of a price
ceiling on cars of £6000. The result is excess demand of 23 million cars (30 – 7), but
prices cannot adjust upwards to clear the market since it is illegal to charge more.
Economists generally do not favour price ceilings because of the costs they
generate. There is a cost to consumers who wish to buy the product at £6000
but who cannot because of the limited supply. Suppliers have an incentive to
maintain supply at a relatively low level because of the low price and so industry

Price
(£000) D
S
24

18

12

6 excess demand

Quantity
0 7 9 15 30 (millions/year)

FIGURE 2.7 PRICE CEILING IN THE CAR MARKET

 M A R K E T A N A LY S I S : D E M A N D A N D S U P P LY 57

output, employment and taxes paid to government may all be lower as a result.
Furthermore, potential problems exist regarding how the 7 million cars will be
allocated among the people demanding 30 million cars.

2.6.2 PRICE FLOOR

A price floor is a price that suppliers can be sure to receive for their output.

A price floor is a minimum price with the purpose of helping the producer/supplier
attain a price higher than the equilibrium price. It is common in the agriculture
sector, as with Europe’s Common Agricultural Policy. The general effects of a price
floor are shown in Figure 2.8.
The price floor is set at £24 000. Suppliers are willing to supply 19 million cars,
4 million more than if the equilibrium price could be earned. The result is excess
supply in this market since quantity demanded is 12 million cars less than quantity
supplied of 19 million. The surplus output may be taken up by a government agency
or perhaps exported. Prices cannot adjust freely downwards to clear the market and
bring demand and supply to equilibrium.

2.6.3 PROBLEMS OF PRICE CEILINGS AND FLOORS

Economists generally do not support the use of price ceilings and floors as they
interfere with the free working of the market system and mean that markets do
not clear. Problems are created which are worse than those the policies are aimed
at solving. Instead of allowing the accumulated choices taken by people on both
demand and supply sides of markets to feed into the market price and quantity
of goods bought and sold, individuals with decision-making power judge what the

Price
(£000) D S
<excess supply>
24

18

12

Quantity
0 7 9 15 19 30 (millions/year)

FIGURE 2.8 PRICE FLOOR IN THE CAR MARKET

58 THE ECONOMIC SYSTEM

‘correct’ market price should be. This removes the contributions of some individuals
to the market process meaning less collective information feeds into the market
outcome. This means that some information of relevance to the market is not used,
or is purposefully ignored, and hence, the economic outcome is not as efficient as
it could otherwise be.

2.7 I N F O R M AT I O N A N D K N O W L E D G E
IN THE MARKET SYSTEM
You will appreciate already that demand and supply curves are not simple features
of an economy but relate to a complex range of factors that together reflect the
behaviour of individual buyers and sellers in markets. The behaviour results from
all of the information used by buyers and sellers when making their economic
decisions and is, therefore, the result of numerous independent decisions made
by unrelated and non-directly communicating individuals seeking to satisfy their
personal economic goals – maximizing their utility. Information available to each
individual informs their decision-making so all relevant information distributed
across a range of individuals is reflected in supply and demand.
The market system is built on individuals’ use of information and their incentives
about how best it should be used. Some of this information is generally available.
Take the case of a firm trying to decide if it should hire an additional worker. It will
know how much the employee will cost, based on the going or market wage rate,
and it will have to make a guess about how much additional revenue the worker
will be able to generate for the firm, maybe using information they already have
about other workers. Using this information, the economic decision to hire or not
is taken.
General information or knowledge that we all possess provides no economic
advantage to us relative to others in the economic system although it is useful
for some decision-making. Specific knowledge is also used in the economic system.
Specific knowledge differs from general knowledge because it is not generally known
or available and can be difficult and/or costly to share with others. It includes:

• Scientific knowledge – e.g. the laws of quantum physics or astrophysics that are not
easily shared with non-specialists.
• Assembled knowledge – e.g. an administrator who has worked dealing with students
in a university department has assembled knowledge about courses offered,
timetables, the marks and standards of the courses, details of assignments,
 M A R K E T A N A LY S I S : D E M A N D A N D S U P P LY 59

deadlines and so forth; e.g. the knowledge of how a machine works and how it
can be fixed if it breaks down. Such assembled information would take time to
be learned by new staff.
• Idiosyncratic knowledge of particular circumstances which if not acted upon swiftly
leads to missed opportunities and, hence, wasted resources – e.g. if more output
is required in a factory then information on whether a specific machine is
operating to capacity will be known to individuals working closely with that
machine; if more products must be distributed, information about which
containers/lorries are not fully loaded is known to employees on the spot.

Some knowledge may be easily redistributed if it can be expressed in facts, phrases

or drawings. Depending on the time it takes to distribute the knowledge, however,
it may still be costly to transfer to other people. Other types of knowledge are of a
tacit nature, made up of perceptions, beliefs, experience and other types of specific
knowledge and can be impossible to explicitly transfer.
The role of knowledge within firms and its central role within the economic
system is discussed by Stewart (1997).

Knowledge is more valuable and more powerful than natural resources, big
factories, or fat bankrolls. In industry after industry, success comes to the
companies that have the best information or wield it most effectively – not
necessarily the companies with the most muscle. WalMart, Microsoft, and
Toyota didn’t become great companies because they were richer than Sears,
IBM, and General Motors – on the contrary. But they had something far more
valuable than physical or financial assets. They had intellectual capital . . .
Intellectual capital is the sum of everything everybody in a company knows
that gives it a competitive edge. Unlike the assets with which business people
and accountants are familiar – land, factories, equipment, cash – intellectual
capital is intangible. It is the knowledge of a workforce: the training and
intuition of a team of chemists who discover a billion-dollar new drug or
the know-how of workmen who come up with a thousand different ways to
improve the efficiency of a factory. It is the electronic network that transports
information at warp speed through a company, so that it can react to the market
faster than its rivals. It is the collaboration – the shared learning – between a
company and its customers, which forges a bond between them that brings the
customer back again and again.
In a sentence: intellectual capital is intellectual material – knowledge, infor-
mation, intellectual property, experience – that can be put to use to create
wealth. It is collective brainpower. It’s hard to identify and harder still to