Market Structures and Dynamics

Role of the Market

• Definition: A market is a venue where buyers and sellers interact to determine the price for exchanging goods or services.
• Buyer and Seller Behavior:
  • Sellers aim to sell at the highest price possible.
  • Buyers seek the lowest prices.
• Economic Problem: The market helps solve the allocation of limited resources to meet unlimited wants through the forces of supply and demand.
• Opportunity Cost: Decisions in the market reflect the opportunity cost related to resources (land, labor, enterprise).

Markets Overview

Factor Market

• Definition: A market where factors of production (like labor and capital) are bought and sold.
• Components: Labor market, physical capital market, raw materials market, entrepreneurial resources.

Product Market

• Definition: A marketplace for final goods and services offered for purchase by consumers and businesses.
• Focus: Sales of finished goods only.

Role of Prices in Market Economies

• Scarcity Reflection: Prices reflect the relative scarcity of goods and resources.
• Resource Allocation: Guide the efficient allocation of resources.
• Incentive Mechanism: Prices incentivize risk-taking and entrepreneurial activities.
• Rationing Device: Prices help markets clear through balancing supply and demand.
• Equilibrium Achievement: Prices facilitate market equilibrium, where supply meets demand.

Demand

Definition

• Demand: The quantity of goods and services that consumers are willing and able to purchase at various prices.
• Utility Basis: Demand is influenced by the satisfaction (utility) derived from consumption.

Types of Demand

• Individual Demand: Demand from a single consumer.
• Market Demand: Total demand from all consumers in the market, computed by summing individual demands.

Law of Demand

• Principle: As the price of a good increases, the quantity demanded typically decreases.
• Exception: Giffen goods may violate this law, where demand increases as prices rise when consumers switch to inferior alternatives.

Supply

Definition

• Supply: The quantity of goods or services that producers are willing to offer for sale at various prices.

Types of Supply

• Individual Supply: Supply from individual producers at different price levels.
• Market Supply: Total supply in an industry at varying prices.
• Effective Supply: Capability of a firm to supply goods/services.

Factors Affecting Supply

• Price of Goods: Higher prices can incentivize increased production.
• Resource Availability: Limited resources cap potential supply.
• Technology State: Advanced technology can lower production costs and increase supply.
• Consumer Preferences: Changes can shift supply dynamics.
• Number of Firms: More firms generally mean increased supply competition.

Law of Supply

• Principle: As prices rise, quantity supplied increases (from the firm's perspective).
• Movements in Supply:
  • Extension: Increase in supply when prices rise.
  • Contraction: Decrease in supply when prices fall.

Market Equilibrium

• Definition: The price level at which the quantity demanded and supplied are equal.
• Price Regulation: Prices act as regulators bringing supply and demand to equilibrium.
• Surplus/Shortage:
  • Surplus occurs when prices are above equilibrium, leading to excess supply.
  • Shortage occurs when prices are below equilibrium, causing demand to outstrip supply.

Elasticity

Elasticity Concepts

• Demand Elasticity: Measures consumer sensitivity to price changes.
• Types of Elasticity:
  • Elastic Demand: Significant response to price changes.
  • Inelastic Demand: Minimal response.
  • Perfectly Elastic Demand: Consumers demand infinite quantity at a set price.
  • Perfectly Inelastic Demand: Consumers will buy regardless of price changes.

Determinants of Price Elasticity of Demand

• Availability of Substitutes: More substitutes lead to higher elasticity.
• Necessity vs. Luxury: Necessities tend to have inelastic demand.
• Proportion of Income: Higher priced goods generally have more elastic demand.

Significance of Elasticity for Producers

• Market Research: Helps producers gauge consumer responsiveness to price changes.
• Revenue Considerations: Producers adjust prices based on demand elasticity to maximize revenue.
• Role of Advertising: Differentiates products in markets with elastic demand.

Market Failures

Causes of Market Failure

• Provision of Public Goods: Merit goods like public transport are beneficial yet underprovided by markets.
• Income Distribution Failures: Inequities requiring government intervention (e.g., social security benefits).
• Pollution and Externalities: Unaccounted costs affecting overall welfare.
• Monopoly Power Abuse: Regulation needed to curb monopolistic practices.
• Market Instability: Fluctuations during business cycles require oversight.

Government Interventions

• Price Controls: Implementing price ceilings (maximum prices) and floors (minimum prices) to protect consumers and producers.
• Monopolistic Structures: Addressing monopolies and oligopolies to encourage competition and fair pricing.

Market Structures

Monopoly

• Characteristics: Single seller, no close substitutes, significant barriers to entry.
• Price Setting: Monopolists can control prices to maximize profits.

Monopolistic Competition

• Characteristics: Many small sellers offering differentiated products.
• Role of Advertising: Critical for attracting customers.

Oligopoly

• Characteristics: Few companies dominate, high barriers to entry, interdependent pricing strategies.
• Non-Price Competition: Firms engage in advertising, loyalty programs, etc.

Examples of Market Structures

• Monopoly: Sydney Water.
• Monopolistic Competition: Local restaurants.
• Oligopoly: Big Four banks in Australia.