Introduction to Markets and Market Failure

Positive Statements

factual & can be proven to be true or false

Normative Statements

based on opinions and beliefs

Value Judgements

what is good, bad or desirable

Basic Economic Problem

finite resources & infinite wants/needs of humans

Resources (definition)

Factors of production (land, labour, capital and enterprise/businesses)

Impact of Scarcity

choices have to be made to maximise efficiency

Scarcity in a Free Market

scarcer = higher price, less scarce = lower price

Opportunity Cost

the loss of the next best alternative (when making a decision)

Examples of economic agents (4):

• Special interest groups (e.g. environmental/trade unions)

• Consumers

• Producers

• Government

3 Economic Questions

1. What to produce (weapons or schools)?

2. Who to produce for (the rich only or everyone)?

3. How to produce it (labour or technology)?

Free-market economy

an economy that has no government intervention in the allocation of resources or the distribution of goods/services

Command economy

an economy in which all of the resources are owned by the state and the government controls the distribution of goods/services

Mixed economy

a blend of the free market and planned economy as individuals, firms and the government own factors of production and distribute goods/services

Marx

1. Free markets

2. Capitalism

3. Workers being exploited

4. Inequality is created

5. A breakdown is created between the classes (i.e. revolution)

• His solution: to abolish private property so the State can share the means of production and ownership with all workers & to become the central planner (deciding how each of the three economic questions would be answered

Smith

1. Free markets

2. Private individuals work in their own self-interest

3. Increased economic productivity/efficiency

• However governments should ensure efficiency in resource allocation

Hayek

• Why command economies are flawed:

1. Information gaps between what economies actually required and what central planners say it required

2. Shortages/surpluses in good/services

3. Low economic productivity/efficiency

Rational

when economic agents can consider the outcome of their choices and recognise the net benefits of each one

Rational agents (and how they act rationally: 4)

• Consumers maximise their utility

• Producers sell goods/services in a way that maximises profit

• Workers balance welfare & consider both pay and benefits

• Governments prioritise the interests of the people they serve to maximise their welfare

Utility

the satisfaction gained from a good/service

Welfare

the wealth, happiness and fortune of a person or group

Example of Irrational Behavior

consumers are more influenced by emotion rather than a rational computation of net benefits

Demand

the amount of a good/service that a consumer is willing and able to purchase at a given price in a given time period

Non-effective demand

when a consumer is willing to purchase a good, but can’t afford to

As the quantity decreases:

the price increases

Factors affecting demand

1. Changes in Real Income

2. Changes in taste/fashion

3. Advertising/branding

4. Changes in the price of substitute goods

5. Changes in the price of complementary goods

6. Changes in population size/distribution

Marginal utility

the extra utility (satisfaction) gained from the consumption of an additional unit of a product

Total utility

The marginal utility of each unit added together

The Law of Diminishing Marginal Utility

‘the utility gained from the next unit is lower than the utility gained from the previous unit’