IB Economics

Markets
 Markets
• A place or situation where buyers and sellers
communicate with exchange in mind
• PRICE is important as a signal and as an incentive
in terms of resource allocation in a correctly-
functioning market economy
• A market is a meeting of buyers and sellers who
do not have to physically meet
• Markets cannot exist unless both buyer and
sellers are involved
 Markets
• Markets include those for wheat, fruit, stocks and bonds and foreign exchange:
• Wheat produced in one place can be sold anywhere in the world
• Between the London stock exchange, the New York stock exchange and the Tokyo
exchange, it is now possible to trade certain stocks 24 hours a day - markets are not
limited to certain intervals of time
• Foreign exchange markets are located in the international telephone networks and
computer hookups
• In some rural markets, fruits, vegetables and fish may be quite expensive in the morning
but be marked down drastically toward the end of the day, particularly if there is no
refrigerated storage available
• Non market sectors include non-governmental organizations (NGOs) such as
charities/volunteer organizations which raise money from the public to pay for goods and
services
• The bulk of non market production is accounted for by government and NGOs:
• Money is provided by tax revenue and donations, and the non market goods and services
are distributed to households and firms
 Demand

• Quantity of a commodity that consumers are

willing and able to purchase at a given period
of time at a given price - what consumers are
willing and able to buy at a price affects the
demand for that good
• Effective demand is a want backed by money
and the willingness to pay
Function of demand: Qn= f [Pn, Y, (P1....Pn-1), T]
 Law of demand
• Law of demand states that as a price of good or service rises, the
quantity demanded will fall; concurrently, if the price of a good or
service falls, the quantity demanded will increase
• The law of demand states that a higher quantity will be demanded at a
lower price assuming other factors such as the price of substitutes are
unchanged
• Quantity demanded refers to a continuous flow of purchases per period
of time
• A single point on the demand curve reflects the quantity demanded at
that price
• The demand curve shows the quantity of a good that consumers want
at each price, assuming they have the effective purchasing power
(income) to pay
 Law of demand
• Price and quantity demanded are negatively related:
• Demand is downward sloping: each increment in consumption leads to
less and less satisfaction, and the consumer will buy more only for a
lower price
• As price rises, the quantity demanded of the good or service tends to fall
• It becomes an increasingly expensive way to satisfy the need or want
associated with the good or service
• People switch in part to some other goods or services to satisfy the same
need, and less will be purchased of the good that has gone up in price
• As the price of the good falls, it becomes relatively cheaper and more of
it will be purchased and less of substitute goods
Fundamental distinction between a movement along the demand curve and
a shift of the demand curve

• Price of a good: A change in the price of a good causes a movement along the demand
curve
• Movements along the demand curve (own price effect) lead to changes in quantity
demanded
• A movement along the demand curve is caused by a change in price; however, a shift of
the demand curve means that more is demanded at each price - this is caused by a
change in any of the determinants of demand (with the exception of price)
• The demand curve is downsloping for several reasons, including the law of diminishing
marginal utility - extra utility gained from the consumption of a good falls
• Therefore, the price must be lower for a person to purchase extra units of a given good
• The income effect states that as prices fall, real income increases
• Consumers can therefore afford to consume a greater quantity, providing a second
reasons for the downsloping curve
• A third reason is the substitution effect, whereby the falling price of a good makes that
good cheaper in relation to other goods (substitutes)
 Determinants of demand/Shifts in the demand curve

• Income, tastes/preferences, price of other/related goods, advertising

• The demand curve will shift out if more is demanded at each price and
is caused by changes in factors other than the price of the good itself:
Substitutes: Goods that can be used in place of one another/different
goods that satisfy the same needs
• If the price of a substitute rises, demand for the good will increase
• If the price of coffee falls, many people will shift from drinking tea to
drinking coffee and the demand curve for tea shifts in to the left
Complements: These are goods which tend to be used jointly
• If the price of a complement rises, demand will decrease.
• If the price of gasoline rises people are motivated to use their car less,
and the demand for cars shifts to the left
 Determinants of demand
• Real income: when income rises, more people can afford to buy cars and the
demand curve for cars shifts to the right for normal goods and a decrease in
demand for inferior goods
• Population: if the population grows/changes composition (old/young) there
are more consumers and demand will shift out to the right
• Tastes and preferences: more people may want the product or service (a
product becomes 'fashionable') and demand shifts out
• Advertising: the more effective the advertising the greater the demand, unless
the government uses negative advertising for things such as the dangers to
health from cigarette smoking
• Other macro factors:
• Legislation
• Access to credit: more credit means it is easier to borrow for durable goods
like cars and demand shifts right
 Exceptions to the law of Demand

Veblen (ostentatious) goods: named after the economist

Veblen and link with his theory of conspicuous
consumption
• If price for a status good rises, then demand for that
good also rises
• People want to be seen buying more expensive goods
– goods with ‘snob’ appeal
• If the price rises, people will buy more because they
are more expensive
 Exceptions to the law of Demand
Giffen goods: goods which are absolutely vital for a person
• All Giffen goods are inferior goods: as income rises, less is purchased
• The income effect is more powerful than the substitution effect, and less is bought as
the price falls; the demand curve is positively sloped
• This usually refers to staple crops such as rice in some parts of China and potatoes
during the Irish potato famine
• As price for the good increases, individuals will be able to buy little of anything else
and instead spend their income purchasing staple crops
• During the Irish famine, families spent 80% of their income on potatoes - as potato
prices fell, real income rose and money was spent on milk and meat instead; quantity
demanded for potatoes fell as prices fell
• Perhaps rice in some areas today could be considered a Giffen good; other than that,
you'll never find one!
Speculative goods: As share prices increases, so does the quantity demanded of
shares, as individuals predict further price increases
 Supply
Willingness and ability for producers to produce
a good at a given price over a given period of
time
Law of supply: a higher quantity of a good will
be supplied at a higher price
• Producers can afford to supply extra units at a
higher price because it allows them to
produce more before AC is greater than MC
Movements along the supply curve (change in P)

• The supply curve shows the quantity producers are willing to supply
at each price
• Law of Supply states that higher quantities will be supplied at higher
prices,all other things unchanged:
• This leads to a movement along the supply curve
• As the extra cost of producing a unit increases, producers need a
higher price to produce the product
• A movement along the supply curve is a change in quantity supplied
resulting from a change in the good price
• All other determinants of supply will change the supply and so will
shift the entire supply curve
• Quantity supplied is a flow of goods or services per unit of time
 Shift of the supply curve

Changes in supply refer to shifts of the whole supply curve

Factors (determinants) causing shifts in the supply curve:
• Increase in number of producers in an industry (new firms
entering a market): leads to an increase in supply
• Prices of factors of production:
• If there are increases, less is supplied at each price (less
profit is being made), and the supply curve shifts left
• If factor prices fall, the supply curve shifts right
• Technological changes: always leads to a rightward shift in
supply
 Shift in supply curve
• Weather: improvements can increase the supply of agricultural products
• Taxes and subsidies (government intervention): increases in taxes lead to
a fall in supply, increases in subsidies leads to an increase in supply
• Changes in the prices of other (jointly produced) goods:
• Sometimes goods are produced jointly such as wool and mutton: if the
price of wool falls dramatically and farmers switch to producing
something else, the price of mutton rises dramatically
• Alternatively, if you could produce two goods from the same factory and
the demand for one rises dramatically:
• Production will switch to that good and its supply will shift out
(rightward)
• Production of the second good will fall and it's supply will shift in
(leftward)
 Effect of taxes and subsidies:

• An increase in corporate taxes increases input

costs for the supplier. Less is produced at each
price – the supply curve shifts leftwards
• A subsidy, or corporate tax credit, reduces
input costs for the supplier. More is produced
at each price level. The supply curve shifts
rightwards.
 Market Equilibrium

• Occurs when quantity demanded equals quantity supplied

• Market clearing price, where supply equals demand
• Only at a price of $8,000 (in diagram at next slide) does quantity demanded equal quantity
supplied
• Price below equilibrium (shortage): households will desire more but firms will not be
prepared to offer as much leading to excess demand
• Inventories will be falling, and sellers can charge a higher price
• The price will edge back up to $8,000 (equilibrium) where the quantity supplied and
demanded will be equal to each other again
• Price above equilibrium (surplus): people will want fewer cars while firms will be only too
happy to supply more leading to excess supply:
• Inventories will be rising and firms will lower prices to clear the carlots
• Households will be happy to buy cars at lower prices
• No equilibrium: where supply is everywhere above demand, nothing will be produced
because the higher price consumers are prepared to pay is less than the minimum price
producers need to supply (e.g., spaceships)
Market equilibrium
 Shifts of Demand and Supply and how the price and quantity are affected

What happens to price and quantity of i-phones

when income increases across the EU and USA

Or When in China, where i-phones are made,

the Chinese currency appreciates and workers
get paid more

Or when doctors reveal a new study that says

cell phones are harmful to health
 Functions of price mechanism
The Functions of Prices:
• Rationing: because resources are scarce and finite, not everyone is
able to buy everything they want; when demand is greater than
supply, then prices are bid up so that the good/service is rationed
out to those who can afford to pay.

• Incentive: when prices are high, then this attracts producers to the
market because it can enable higher profits to be earned.

• Signalling: prices help to determine where and how resources

should be allocated; if prices increase, this signals to producers that
demand is probably high and that they should increase production.
 Goods or services with no price:

• In most countries, roads are available free of charge and

people will use them out to the point where demand
intersects the horizontal axis leading to excess demand
• Rationing does not take place: there is overcrowding
(tragedy of the commons)
• In some countries medicine is free and again there is excess
demand which is likely to get worse as populations age
• Rationing takes place through queuing (typically the
government issues coupons to stop hoarding)
 Four Laws of Demand & Supply:

1. A rise in demand: excess demand, inventories fall, price and

quantity increase:
• The rise in price acts as a rationing device to lower demand but
encourages existing firms to produce more and for other firms to
join the industry, thus moving resources into the industry to
respond to the increase in demand
2. A fall in demand: excess supply, inventories rise, price and
quantity decrease
3. A rise in supply: excess supply, inventories rise, price falls and
quantity rises
4. A fall in supply: excess demand, inventories fall, price rises and
quantity falls
Diagram of consumer and producer surplus
 Reading:
• Economics 2020 Edition, Oxford, Jocelyn Blink
& Ian Dorton, chapter 3, 5, 7.