Unit 2 - Economic system and demand

What is an economic system?

• An economic system is a framework or a set of mechanisms that works out the how, what and for whom questions. 

• The following are some standards that is used to distinguish among economic systems: 

• Who owns the resources? 

• What decision-making process is used to allocate resources and products? 

• What types of incentives guide economic design makers? 

What are the three economies and their quick definitions?

1. Market economy - An economy that allocates resources through the forces of demand and supply and prices being determined on the market 

2. Command economy - An economy where the government makes the decision about the production and distribution of goods 

3. Mixed economy - an economy that has features of both market and command economic systems 

What is economic freedom?

economic decisions and choices are left to the individual 

What is resource management?

The distribution of resources

What is distribution of income?

the way income is divided among the members of the society 

Explain what Market economy is, its advantages and disadvantages

• Market economy (aka capitalism) is based on private property and the market is based on private property and the market. 

• Rights are given to individuals and businesses, they own all farm shops, hospitals houses and other businesses 

• Individuals have freedom in choosing how they make money and how to spend, they are motivated by profit and self-interest. 

Advantages: 

• Markets allocate resources and are thus more effective in the allocation and distribution of goods and services. 

• Businesses are motivated by profit and thus will respond fast to consumer preferences 

• People have economic freedom; freedom of consumption, production and occupation 

• There are more technological innovations under market economy 

Disadvantages:

• System is based on ‘ability to pay’ and not on needs 

• Public and merit goods can be under-provided if the market fails (things like hospitals, defense and law and order) 

• Demand and supply determine the employment leading to unemployment rates to be high 

• There is unequal distribution of income and wealth 

Explain what a command economy is, its advantages and disadvantages

• Government owns all the productive resources and businesses. They decide what local people will produce and sell (they are in charge of the what, how and whom) 

• Here demand and supply does not play a role in the economy 

Advantages: 

• A planning office decides how the resources are allocated by estimating the products that people want, this way wasteful competition is avoided 

• There may be more equal distribution of income 

• And inflation may be controlled  

Disadvantages: 

• There won’t be any economic freedom 

• Demand and supply will be difficult to balance because there is no markets 

• Without the motivation of profit, businesses will find it difficult to be efficient 

• A big bureaucracy would be needed  

• Consumer needs and preferences wont be taken into consideration 

What is the definition of demand?

“Quantity demanded is the amount of a good that buyers are willing and able to purchase”

Many things determine quantity demanded, the most central one is price

What are the other influences of demand?

Population size 

• A larger population leads to increased demand. Especially true for necessities like food and housing 

• Favorable preferences increase demand and vice versa 

Demographic shifts 

• Age, gender, or ethnicity shifts demand. Certain demographics may require more of a certain good or service 

Consumer tastes 

• Trends, fashion, and advertising play a role in shaping preferences 

Cultural factors 

• Cultural values and beliefs can impact demand. Products that align more with cultural norms will be more popular 

Expected future prices 

• If the price of the good is expected to rise the demand for it currently will increase 

Prices of related goods  

Expected future income 

• Increase in future income increases the current demand, they buy more of the most goods and the demand shifts the curve to the right 

• Normal good is one for which he demand increases as income increases 

• Inferior good is one which demand decreases as income increases 

What does the law of demand state? What is a demand schedule?

The law of demand states that when the price of a good rises the quantity demanded for the good falls, and when the prices for the good falls the quantity demanded rises.

 “A demand schedule is a table that shows the relationship between the price of a good and the quantity demanded” 

Market demand VS individual demand

• Where individual demand focuses on the demand of one person, market demand looks at the sum of the individual demands. In other words, market demand is the total demand for a good or service that an individual is willing to and able to pay/purchase 

• Market demand curve shows how the total quantity demanded of a good varies as price varies whilst keeping other factors constant 

What causes shifts in the demand curve?

Any change that increases the quantity demanded at every price shifts the demand curve to the right, this is called an increase in demand, whereas any change that reduces the quantity demanded at every price shifts the demand curve to the left, this is called a decrease in demand. 

• Changes in the price causes movement along the demand curve, which changes (alters) the quantity demanded. This is Movement along the curve 

• Changes in the factors in demand, like income or preference shift the entire curve. This is Shift of the demand curve 

What does income have to do with demand?

A lower income results in consumers buying less of the goods. If demand falls when income falls the good is a called a normal good. 

• Def: “A normal good is a good for which, other things equal, an increase in income leads to an increase in demand” 

Not all goods are normal. If the demand for the good rises when income falls, the good is called an inferior good 

• Def: “A inferior good is a good for which, other things equal, an increase in income leads to a decrease in demand” 

Why do prices of related goods matter?

• When the price of one good falls and reduces the demand for another good, the two goods are called substitutes. Substitutes are often products that can be used in place of another  

• Def: “Substitute goods is when an increase in the price of one lead to an in the demand for the other”  

• When the fall of a goods price raises the demand for another the goods are said to be complements. Complement goods are goods that are used together 

• Def: “Complement goods are goods where one increases in price leads to the decrease in demand in another” 

What role do expectations play in demand?

• Expectations of the future effect buyers' demand of goods or services now. If a buyer expects their income to increase next month, they may decide to spend more now. If the buyer expects that a goods price will fall next month, the buyer will be less willing to spend more now. 

What does market demand depend on?

It depends on the number of buyers