Example: North Korea
Advantages: efficient use of resources, more choice & potential to make lots of money.
Disadvantages: profit maximisation aims mean that public goods are not likely to be supplied & external costs not accounted for.
No pure market economies exist in the world.
Example: United Kingdom
In any country, we can catagorize production into three or four main industries:
Movement along the Demand Curve (Price)
A change in price causes a movement along the curve
Shift of the Demand Curve
A shift of the demand curve represents an increase or decrease of demand at a given price level. This may be because of:
Movement along the Supply Curve (Price)
A change in price causes a movement along the curve
Shift of the Supply Curve
A shift of the supply curve represents an increase or decrease in the quantitiy supplied at each & every price. Causes of shifts in supply:
The equilibrium price is the point at which demand and supply are equal (where they cross on the diagram). It is also called the market clearing price since it is the point at which all the items supplied are demanded - therefor clearing the market of all the stock.
Consumers want low prices & suppliers want higher prices, this leads to adjustments in the price of products until the equilibrium point is reached.
This situation occurs when the price level is too high which results in a larger quantity supplied than quantity demanded.
Suppliers want to sell the extra stock that they have before it goes bad or out of season so they will lower the price. This leads to an expansion in the quantity demanded and a contraction in the quantity supplied bringing the market back into equilibrium.
This occurs when the price is set too low which result in a larger quantity being demanded than there is available from the suppliers.
Suppliers realise that they can charge a higher price and still sell more products so the price level rises which leads to a contraction in demand (some people wont buy at the higher price) and an extension in supply, bringing the market back into equilibirum.
Price Elasticity of Demand measures the responsiveness between a change in price and the effect on quantity demanded. Measured using formula:
PEoD = (% Change in Quantity Demanded)/(% Change in Price)
Price Inelastic; tells us that a great change in price results in a small change in quantity demanded. Has a PED of less than 1. Usually goods with low starting price or necessities.
Price Elastic; tells us that a small change in price results in a large change in quantity demanded. Has a PED of more than 1. Usually luxuries or goods with many substitutes
Market Clearing Mechanism
The forces of supply and demand utilize fluctuations in price to achieve equilibrium and clear the market.
An exceptionally long drought in Spain destroys a significant proportion of the olive harvest. The immediate effect is likely to be excess demand (B-A). This is then corrected as the decrease in supply leads to higher prices (P1) and subsequently a contraction in demand until demand and supply are in equilibrium again.
The following year the climate leads to a much better harvest of olives. This leads to a situation of excess supply (A-B). To correct this, the price decreases to the point at which the extension in demand brings the market back into equilibrium.
The presence of competition between suppliers in market systems enables consumers to have choice. Firms use price as one form of competition, this leads to lower prices for consumers and greater efficiency for firms as they attempt to minimize costs and maximize profits.
Competition also encourages better allocation of resources as firms that quickly recognize changes in demand and switch their production into growing markets can benefit from increased profit.
Firms that fail to recognize changes in consumers demand and allocate resources ineffectively are likely to experience declining profits and eventually may go out of business.
When considering the cost of production or offering a service we need to take into account more than just the cost to the company. There are wider costs that affect society such as air polltion that are not accounted for on the price.
Private costs: these are the costs to individuals of consuming a product, often the monetary value, but sometimes a health cost such as smoking. They are also the costs to a firm (fixed and variable costs) of production.
Private benefits: the benefit to an individual from consuming a product, often satisfaction, more knowledge etc. In the case of a firm these are likely to be the profits that are made.
External costs: the costs of production or consumption of an item to a third party - litter, air pollution, water pollution are examples, these are often called externalities.
External benefits: the benefits of production or consumption to a third party - other firms & society may benefit from the skills that workers learn through their jobs such as first aid, it skills etc.
To establish the total cost or benefit to society the total value of the private costs and eternal costs needs to be calculated. The sum of the private and external benefits need to be calculated. If the social cost is greater than the social benefit then the resources & factors of production should be used ot produce something else that is more socially beneficial.