How Markets Work

How do economic agents make rational decisions?

• Consumers → maximise utility (amount of satisfication gained from consuming a good/service)

• Firms → maximise profits

What is demand?

Quantity of goods/services that will be bought at a given price and time

How does a Demand Curve look like?

Why does the Demand curve go from the top left to the bottom right?

The law of diminishing utility - the utility gained fron consuming a unit will decrease as more units are consumed (e.g if more pizza eaten, less satisfication gained by a person)

What causes a movement along the demand curve?

Price changes → extension or contraction of demand

What five factors cause a shift in the demand curve?

Changes in:

• Income

• Price of other goods

• Population

• Preferences

• Advertising

How to find the market demand curve from indivdual demand curves?

Add the firms’ demand curves together to get the market demand curve

What is consumer surplus?

The difference between the price the consumers are willing to pay + the price they actually pay (for the consumers who got a good deal)

What is supply?

Quantity of goods that sellers are prepared to sell at a given price + time

How does a supply curve look like?

Why does the supply curve go from the bottom left to the top right?

If the price of a good increases, producer are likely to supply more to take advantage of higher prices

What causes a movement along the supply curve?

Price changes → extension or contraction of supply

What three factors cause a shift in the supply curve?

Changes in:

• Cost of production

• Tech

• Indirect taxes + subsidies

What is producer surplus?

The difference between the price the producers are willing to sell at + the price they actually sell at (for the producer who got a good deal)

What does the price mechanism graph look like?

• Equilbrium price - demand = supply

• Excess demand - quantity demanded is greater than supply at the current price

• Excess supply - quantity demanded is less than supply at the current price

What happens to consumer + producer surplus when there’s an increase in demand?

• Consumer surplus increases to UVp₁

• Producer surplus decreases to BY₁

What are the three roles of the price mechanism?

• Signaling - signals which goods/services to allocate Factors of Production to

• Incentives - rising prices → attracts producers to supply resources

• Rationing - spread resources to different good/services

What are two advantages of the price mechanism?

• Allocates resources naturally

• Efficient over time

What are two disadvantages of the price mechanism?

• Buyers/seller don’t have full info

• Irrational decisions

• Immobile factors of production → can’t allocate resources fast enough

What are the five relationships between markets?

• Complements - consumer likely to buy another good when buying one (e.g golf clubs supply increases → golf balls demand increases)

• Substitutes - competitors (e.g coke supply increases → pepsi demand decreases)

• Derived (Joint) demand - good demanded because it is needed for another product (e.g yoghurt demand increases → milk demand increases)

• Composite demand - good needed for multiple products (e.g steel for cars demand increases → steel for boats demand decreases)

• Joint supply - one good supplies two different products at the same time(e.g beef demand increases → leather supply increases)

What are three reasons consumers don’t act rationally?

• Consideration of other people’s behavior - trends

• Habitual behavior - don’t try new stuff even if better/cheaper

• Consumer weakness at computation - consumers have difficulty calculating best price