1a kno how on intro to markets

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UNIT 1: KNO-HOW! ONTHE PRICE MECHANISM

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The price mechanism

Students should be able: To explain the functions of the price mechanism.Examine how prices respond to changes in consumer

preferences & provide incentives to producers.

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The price mechanism

Background reading:Nutter‘The Cartoon Introduction to Economics’ Yoram Bauman

p.126 – p142

Introduction to marketsMarket

any place or process that brings together buyers and sellers with a view to agreeing a price

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Introduction to marketsTypes of markets:

Organised markets – commodities e.g. rubber, oil, sugar, wheat, gold, copper

Financial markets – stocks, shares, currencies, financial instruments

Goods markets – the supply and demand of goods and services in general, food, clothing, leisure, houses, cars, ‘farmers’

Factor markets – the supply and demand of factors of production – land, labour and capital

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Introduction to marketsA market does NOT have to be a physical place – like

a shop!The market place consists of all those who have

items/services for sale and all those who are interested in buying those items/services

Many businesses have global markets because of the developments in technology – see www.amazon.co.uk

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Introduction to markets

Demand – the amount consumers desire to purchase at various alternative prices

Demand – reflects the degree of value consumers place on items – price and satisfaction gained from purchase (utility)

Supply – the amount producers are willing to offer for sale at various prices

Supply – reflects the cost of the resources used in production and the returns/profits required

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The market systemMarket consists of:

Consumers: create a demand for a product.Demand

What consumers will buy and are able to buySupply

What quantities firms will provide at a certain price.

In a free market, we combine the forces of demand and supply in order to determine the market price of a good or service.

Interactive graph from Thinkeconomics

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Market clearing price

Market clearing priceP is known as the market clearing price — the price at

which supply exactly meets demand. If the price is too high, then supply > demand, and we have excess supply, or a surplus or glut. To get rid of the excess supply, producers will have to lower the price, and so the market clearing price will eventually be reached. If the price is too low, then demand > supply, and we have excess demand or a shortage. To get rid of the excess demand, the price will rise towards the market clearing price, causing consumers to leave the market as the good becomes more expensive than the price they are willing to pay.

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The Market

Price (£)

Quantity Bought and Sold (000s)

S

D

£5

600

D1

300

Surplus

£3

450

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The Market

Price (£)

Quantity Bought and Sold (000s)

S

D

£5

600

S1

100

Shortage

£8

350

Kno-how! on the function of pricesRationing: because resources are scarce and finite, not

everyone is able to buy everything they want; when demand is greater than supply, then prices rise 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.