UNIT II

MARKET
A market is any one of a variety of different systems, institutions, procedures, social relations
and infrastructures whereby person‘s trade, and goods and services are exchanged, forming part of the
economy. It is an arrangement that allows buyers and sellers to exchange things. Markets vary in size,
range, geographic scale, location, types and variety of human communities, as well as the types of goods
and services traded.
Some examples include local farmers‘markets held in town squares or parking lots, shopping
centers and shopping malls, international currency and commodity markets, legally created markets such
as for pollution permits, and illegal markets such as the market for illicit drugs.
In mainstream economics, the concept of a market is any structure that allows buyers and sellers
to exchange any type of goods, services and information. The exchange of goods or services for money is
a transaction. Market participants consist of all the buyers and sellers of a good who influence its price.
This influence is a major study of economics and has given rise to several theories and models
concerning the basic market forces of supply and demand. There are two roles in markets, buyers and
sellers. The market facilitates trade and enables the distribution and allocation of resources in a society.
Markets allow any tradable item to be evaluated and priced. A market emerges more or less
spontaneously or is constructed deliberately by human interaction in order to enable the exchange of
rights (cf. ownership) of services and goods.
Historically, markets originated in physical marketplaces which would often develop into or from
small communities, towns and cities.

TYPES OF MARKETS
Although many markets exist in the traditional sense such as a marketplace there are various other types
of markets and various organizational structures to assist their functions. The nature of business
transactions could define markets.

Financial markets
Financial markets facilitate the exchange of liquid assets. Most investors prefer investing in two
markets, the stock markets and the bond markets. NYSE, AMEX, and the NASDAQ are the most
common stock markets in the US. Futures markets, where contracts are exchanged regarding the future
delivery of goods are often an outgrowth of general commodity markets.
Currency markets are used to trade one currency for another, and are often used for speculation
on currency exchange rates. The money market is the name for the global market for lending and
borrowing.

Prediction markets
Prediction markets are a type of speculative market in which the goods exchanged are futures on
the occurrence of certain events. They apply the market dynamics to facilitate information aggregation.

Organization of markets
A market can be organized as an auction, as a private electronic market, as a commodity
wholesale market, as a shopping center, as a complex institution such as a stock market, and as an
informal discussion between two individuals.
Markets of varying types can spontaneously arise whenever a party has interest in a good or
service that some other party can provide. Hence there can be a market for cigarettes incorrectional
facilities, another for chewing gum in a playground, and yet another for contracts for the future delivery
of a commodity. There can be black markets, where a good is exchanged illegally and virtual markets,
such as eBay, in which buyers and sellers do not physically interact during negotiation. There can also be
markets for goods under a command economy despite pressure to repress them.
Mechanisms of markets
In economics, a market that runs under laissez-faire policies is a free market. It is "free" in the
sense that the government makes no attempt to intervene through taxes, subsidies, minimum, price
ceilings, etc. Market prices may be distorted by a seller or sellers with monopoly power, or a buyer with
monopsony power.
Such price distortions can have an adverse effect on market participant's welfare and reduce the
efficiency of market outcomes. Also, the level of organization or negotiation power of buyers, markedly
affects the functioning of the market. Markets where price negotiations meet equilibrium though still do
not arrive at desired outcomes for both sides are said to experience market failure.

Study of markets
• The study of actual existing markets made up of persons interacting in space and place in diverse
ways is widely seen as an antidote to abstract and all-encompassing concepts of ―the market‖
and has historical precedent in the works of Fernand Braudel and Karl Polanyi.
• The latter term is now generally used in two ways. First, to denote the abstract mechanisms
whereby supply and demand confronts each other and deals are made.
• In its place, reference to markets reflects ordinary experience and the places, processes and
institutions in which exchanges occur.
• Second, the market is often used to signify an integrated, all-encompassing and cohesive
capitalist world economy.
• A widespread trend in economic history and sociologyis skeptical of the idea that it is possible to
develop a theory to capture an essence or unifying thread to markets.
• For economic geographers, reference to regional, local, or commodity specific markets can serve
to undermine assumptions of global integration, and highlight geographic variations in the
structures, institutions, histories, path dependencies, forms of interaction and modes of self-
understanding of agents in different spheres of market exchange Reference to actual markets can
show capitalism not as a totalizing force or completely encompassing mode of economic activity,
but rather as ―a set of economic practices scattered over a landscape, rather than a systemic
concentration of power
DEMAND & SUPPLY

The Basic Decision-Making Units

• A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the
primary producing units in a market economy.
• An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea
or a new product and turning it into a successful business.
• Households are the consuming units in an economy.

The Circular Flow of Economic Activity

• The circular flow of economic activity shows the connections between firms and households in input
and output markets.
• Input Markets and Output Markets
• Output, or product, markets are the markets in which goods and services are exchanged.
• Input markets are the markets in which resources—labor, capital, and land—used to produce products,
are exchanged.

Input Markets
Input markets include:
• The labor market, in which households supply work for wages to firms that demand labor.

• The capital market, in which households supply their savings, for interest or for claims to future
profits, to firms that demand funds to buy capital goods.
• The land market, in which households supply land or other real property in exchange for rent.

DETERMINANTS OF HOUSEHOLD DEMAND

• The price of the product in question.
• The income available to the household.
• The household‘s amount of accumulated wealth.
• The prices of related products available to the household.
• The household‘s tastes and preferences.
• The household‘s expectations about future income, wealth, and prices.

Quantity Demanded
• Quantity demanded is the amount (number of units) of a product that a household would buy in
a given time period if it could buy all it wanted at the current market price.
Demand in Output Markets
• A demand schedule is a table showing how much of a given product a household would be
willing to buy at different prices.
• Demand curves are usually derived from demand schedules.

• The demand curve is a graph illustrating how much of a given product a household would be
willing to buy at different prices.

The Law of Demand

• The law of demand states that there is a negative, or inverse, relationship between price
and the quantity of a good demanded and its price.
• This means that demand curves slope downward.

Other Properties of Demand Curves

• Demand curves intersect the quantity (X)-axis, as a result of time
limitations and diminishing marginal utility.
• Demand curves intersect the (Y)-axis, as a result of limited incomes and wealth.

Income and Wealth

• Income is the sum of all households‘ wages, salaries, profits, interest payments, rents, and other
forms of earnings in a given period of time. It is a flow measure.
• Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a
stock measure.
• Normal Goods are goods for which demand goes up when income is higher and for which
demand goes down when income is lower.
• Inferior Goods are goods for which demand falls when income rises.
 • Substitutes are goods that can serve as replacements for one another; when the price of one
increases, demand for the other goes up. Perfect substitutes are identical products.

• Complements are goods that ―go together‖; a decrease in the price of one results in an increase
in demand for the other, and vice versa.

Shift of Demand versus Movement along a Demand Curve

• A change in demand is not the same as a change in quantity demanded.

• In this example, a higher price causes lower quantity demanded.
• Changes in determinants of demand, other than price, cause a change in demand, or a shift of the
entire demand curve, from DA to DB.

A Change in Demand versus a Change in Quantity Demanded

• When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it
was prior to the shift, for each and every price level.
 • Demand for a good or service can be defined for an individual household, or for a group of
households that make up a market.
• Market demand is the sum of all the quantities of a good or service demanded per period by all
the households buying in the market for that good or service.

Assuming there are only two households in the market, market demand is derived as follows:

Supply in Output Markets

A supply schedule is a table showing how much of a product firms will supply at different prices.
Quantity supplied represents the number of units of a product that a firm would be willing and able to
offer for sale at a particular price during a given time period.

The Law of Supply

• The law of supply states that there is a positive relationship between price and quantity of a
good supplied.
• This means that supply curves typically have a positive slope.

Determinants of Supply
• The price of the good or service.
• The cost of producing the good, which in turn depends on:
• The price of required inputs (labor, capital, and land),
 • The technologies that can be used to produce the product,
• The prices of related products.

A Change in Supply versus a Change in Quantity Supplied

• A change in supply is not the same as a change in quantity supplied.

• In this example, a higher price causes higher quantity supplied, and a move along the demand
curve.
• In this example, changes in determinants of supply, other than price, cause an increase in
supply, or a shift of the entire supply curve, from SA to SB.

A Change in Supply versus a Change in Quantity Supplied

• When supply shifts to the right, supply increases. This causes quantity supplied to be greater than it was
prior to the shift, for each and every price level.
A Change in Supply versus a Change in Quantity Supplied

• The supply of a good or service can be defined for an individual firm, or for a group of firms
that make up a market or an industry.
• Market supply is the sum of all the quantities of a good or service supplied per period by all the
firms selling in the market for that good or service.

Market Supply
As with market demand, market supply is the horizontal summation of individual firms’ supply
curves.

Market Equilibrium
• The operation of the market depends on the interaction between buyers and sellers.
• Equilibrium is the condition that exists when quantity supplied and quantity demanded are
equal.
• At equilibrium, there is no tendency for the market price to change.
Market Equilibrium

• Only in equilibrium is quantity supplied equal to quantity demanded.

• At any price level other than P0, the wishes of buyers and sellers do not coincide.

Market Disequilibria

• Excess demand, or shortage, is the condition that exists when quantity demanded exceeds
quantity supplied at the current price.
• When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is
restored.
 • Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity
demanded at the current price.
• When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium
is restored.

PRICE, INCOME AND CROSS ELASTICITY

• Elasticity – the concept
• The responsiveness of one variable to changes in another
• When price rises, what happens to demand?
• Demand falls
• BUT!
• How much does demand fall?
• If price rises by 10% - what happens to demand?
• We know demand will fall
• By more than 10%?
• By less than 10%?

Elasticity measures the extent to which demand will change

Elasticity
4 basic types used:

• Price elasticity of demand

• Price elasticity of supply
• Income elasticity of demand
• Cross elasticity

Price Elasticity of Demand

– The responsiveness of demand to changes in price
– Where % change in demand is greater than % change in price – elastic
– Where % change in demand is less than % change in price - inelastic

If the answer is between -1 and infinity: the relationship is elastic Note: PED has – sign in front of it;
because as price rises demand falls and vice-versa (inverse relationship between price and demand)
Elasticity
• If demand is price elastic:
• Increasing price would reduce TR (%Δ Qd > % Δ P)
• Reducing price would increase TR (%Δ Qd > % Δ P)
• If demand is price inelastic:
• Increasing price would increase TR (%Δ Qd < % Δ P)
• Reducing price would reduce TR (%Δ Qd < % Δ P)

Income Elasticity of Demand:

– The responsiveness of demand to changes in incomes
• Normal Good – demand rises as income rises and vice versa
• Inferior Good – demand falls as income rises and vice versa
• Income Elasticity of Demand:
• A positive sign denotes a normal good
• A negative sign denotes an inferior good

Cross Elasticity:
• The responsiveness of demand of one good to changes in the price of a related good – either a substitute
or a complement
• Goods which are complements:
– Cross Elasticity will have negative sign (inverse relationship between the two)
• Goods which are substitutes:
– Cross Elasticity will have a positive sign (positive relationship between the two)

Price Elasticity of Supply:

– The responsiveness of supply to changes in price
– If Pes is inelastic - it will be difficult for suppliers to react swiftly to changes in price
– If Pes is elastic – supply can react quickly to changes in price

Determinants of Elasticity
• Time period – the longer the time under consideration the more elastic a good is likely to be
• Number and closeness of substitutes – the greater the number of substitutes, the more elastic
• The proportion of income taken up by the product – the smaller the proportion the more inelastic
• Luxury or Necessity - for example, addictive drugs

Importance of Elasticity
• Relationship between changes in price and total revenue
• Importance in determining what goods to tax (tax revenue)
• Importance in analysing time lags in production
• Influences the behaviour of a firm
CONSUMER MARKETS AND CONSUMER BUYER BEHAVIOR Consumer Buying Behavior
• Consumer Buying Behavior refers to the buying behavior of final consumers (individuals &
households) who buy goods and services for personal consumption.
• Study consumer behavior to answer: ―How do consumers respond to marketing efforts the
company might use?‖

Factors Affecting Consumer Behavior: Culture

• Most basic cause of a person's wants and behavior.
• Values
• Perceptions

Subculture
• Groups of people with shared value systems based on common life experiences.
• Hispanic Consumers
• African American Consumers
• Asian American Consumers
• Mature Consumers

Social Class
• People within a social class tend to exhibit similar buying behavior.
• Occupation
• Income
• Education
• Wealth
Types of Buying Decisions

The Buyer Decision Process

Step 1. Need Recognition Need Recognition
Difference between an actual state and a desired state

Step 2. Information Search

Step 3. Evaluation of Alternatives

Step 4. Purchase Decision

Step 5. Post purchase Behavior

Stages in the Adoption Process
• AWARENESS
• INTEREST
• EVALUATION
• TRIAL ADOPTION

Adoption of Innovations

ECONOMIES & DISECONOMIES OF SCALE

Production and Cost in the Long Run
• The key difference between the short run and the long run is that there are no diminishing returns in the
long run.
• Diminishing returns occur because workers share a fixed facility. In the long run the firm can expand its
production facility as its workforce grows.

WHAT IS SCALE?
• By scale of an enterprise or size of a plant we mean the amount of investment in fixed factors of
production
• Costs of production are lower in larger plants than in smaller ones
• This is due to economies of large-scale production
• The term ‗economies‘ refers to cost advantages
• When these economies are over-exploited the result may be cost disadvantages, i.e. diseconomies.

ECONOMIES OF SCALE
• Economies of scale: a situation in which an increase in the quantity produced decreases the long-run
average cost of production.
• Economies of scale refer to cost savings associated with spreading the cost of indivisible inputs and
input specialization.
• When economies of scale are present, the LAC curve will be negatively sloped.
Long-run Average Cost
• Long-run average cost (LAC) is total cost divided by the quantity of output when the firm can choose a
production facility of any size.
• The LAC curve describes the behavior of average cost as the plant size expands. Initially, the curve is
negatively sloped, and then beyond some point, it becomes horizontal.
Long-run Average Cost
• When long-run total cost is proportionate to the quantity produced, long-run average cost
does not change as output increases. The long-run average cost curve is horizontal for 7 or more rakes per
hour. Labor Specialization
• In a large operation, each worker specializes in fewer tasks thus is more productive than his or
her counterpart in a small operation. • Higher productivity (more output per worker) means lower labor
costs per unit of output, thus lower production costs (ever-decreasing average cost).

Minimum Efficient Scale

• The minimum efficient scale describes the output at which economies of scale are exhausted
and the long-run average cost curve becomes horizontal.
• Once the minimum efficient scale has been reached, an increase in output no longer decreases
the long-run average cost.

DISECONOMIES OF SCALE
• A firm experiences diseconomies of scale when an increase in output leads to an increase in
long-run average cost—the LAC curve becomes positively sloped.
• Diseconomies of scale may arise for two reasons:
– Coordination problems
– Increasing input costs
• After firm has reached its efficient scale, further increases in number of workers will lead to
inefficiency.
• Co-ordination of different processes becomes difficult and decision-making process becomes
slow
• Supervision of workers becomes difficult, management problems get out of hand with adverse
effects on managerial efficiency.

TYPES OF ECONOMIES OF SCALE

External Economies
- Economies available to all firms in the industry.
- For eg. Construction of roads, railways in an area reduces costs for all firms in that area
- Discovery of a new technique, rise of industries using by-products, availability of skilled labour through
the establishment of special technical schools
- External economies usually occur when an industry is heavily concentrated in a particular area.

Internal Economies of Scale

- Internal economies are available to a particular firm and give it an advantage over other firms engaged
in the industry
- Arise from the expansion of the size of a particular firm
- From a managerial point of view internal economies are most important as they can be effected by
managerial decisions of an individual firm to change its size/scale
- Internal economies arise due to a firm‘s own expansion while external economies arise due to expansion
of some other industry or due to some external factor.

Labour Economies
- Reduction in labour costs per unit due to increasing division/specialization of labour
- Arise due to increase in the skill of workers and saving of time involved in changing from one operation
to another
- Many operations may be performed mechanically rather than manually
- Economies are maximum where products are complex and the manufacturing processes can be sub-
divided.

Technical Economies
- Derived from the use of scientific processes and machines that a large production firm can afford.

Managerial Economies
- -With the increase in the size of a firm, the efficiency of management increases because of greater
specialization in managerial staff
-Experts in a large firm can be hired to look after various divisions like purchasing, sales, production,
financing, personnel.

Marketing Economies
- A large firm can obtain economies in purchasing and sales as it has bulk requirements and can hence get
better terms
- It gets the advantage of prompt deliveries, careful attention and special facilities from its suppliers
- A large firm can also spread its advertising cost over bigger output.

Economies of Vertical Integration

- Larger firm can integrate a number of stages of production
- Production is better planned and this leads to cost control
- Eg. Oil refining companies controlling distribution, i.e. owning petrol pumps-forward integration, or
controlling oil reserves through oil exploration backward integration

Financial Economies
- Larger firms get credit more easily and also on better terms
- Better image, easier access to capital/stock markets.

Economies of Risk-spreading
- Larger size of business, greater scope for spreading of risks through diversification
- Diversification can be either of products or of markets.

COST ANALYSIS
The Object of Cost Analysis
• Managers seek to produce the highest quality products at the lowest possible cost.
• Firms that are satisfied with the status quo find that competitors arise that can produce at lower costs.
• The advantages once assigned to being large firms (economies of scale and scope) have not provided the
advantages of flexibility and agility found in some smaller companies.
• Cost analysis is helpful in the task of finding lower cost methods to produce goods and services

Meaning of Cost
There are Many Economic Cost Concepts
• Opportunity Cost -- value of next best alternative use.
• Explicit vs. Implicit Cost -- actual prices paid vs. opportunity cost of owner supplied resources.

Depreciation Cost Measurement. Accounting depreciation (e.g., straight-line depreciation) tends

• to have little relationship to the actual loss of value
• » To an economist, the actual loss of value is the true cost of using machinery.

Inventory Valuation Accounting valuation depends on its acquisition cost.

• » Economists view the cost of inventory as the cost of replacement.
Unutilized Facilities. Empty space may appear to have "no cost‖
• » Economists view its alternative use (e.g., rental value) as its opportunity cost.

Measures of Profitability. Accountants and economists view profit differently.

• » Accounting profit, at its simplest, is revenues minus explicit costs.
• » Economists include other implicit costs (such as a normal profit on invested capital).

Economic Profit = Total Revenues Explicit Costs Implicit Costs Sunk Costs -- already paid for, or there
is already a contractual obligation to pay
• Incremental Cost - - extra cost of implementing a decision = D TC of a decision
• Marginal Cost -- cost of last unit produced = ¶ TC/ ¶ Q

SHORT RUN COST FUNCTIONS

• TC = FC + VC fixed & variable costs
• ATC = AFC + AVC = FC/Q + VC/Q .