The economic problem is the unlimited wants that consumers have with limited resources available. Three questions need to be asked when determining a decision, which are "what to produce?" "How to produce?" and "who will receive the goods and services?
The importance of relative price in reflecting opportunity costs in the goods and services and factor markets
The market price paid by consumers for goods and services reflect opportunity costs. Markets for productive resources (natural, human and capital), known as factor markets, determine the opportunity costs of productive resources. Market price can also be used to help determine the best way to allocate scarce resources.
Demand and supply
Demand (demand is the willingness to buy coupled with the ability to buy it. Goods that are demanded must give satisfaction (or utility))
Law of demand- the lower the product"s price, the greater the quantity that people will buy, assuming ceteris paribus.
Individual demand- a demand by individuals for goods and services
Market demand- demand by all consumers for a particular good or service.
The demand curve- shows the relationship between prices, quantity and demand for a product in a graphical form.
Factors affecting demand:
Price- generally the higher the price, the lower the demand for a good or service
Income- the higher the income, the more an individual/household can consume
Population- a growing population means there are more potential consumers
Tastes- influences what the consumer wants to buy
Prices of substitutes and complements- a substitute is a product that could be used in place of another, a complement is a good that is used in conjunction with another.
Expected future prices- if prices are expected to decrease, consumers may choose to delay the purchase for the good, as it reduces opportunity costs. However, if prices are expected to increase, consumers may purchase moor goods now with the assistance of credit.
Movements along the demand curve
Contraction in demand is influenced by the price of the product rising.
Expansion in demand is influenced by the reduction in the price for a good.
Shifts of the demand curve
An increase in demand is influence by external factors (i.e. factor other than price). It is when the demand curve is shifted to the right.
A decrease in demand is influence by external factors (i.e. factor other than price). It is when the curve is shifted to the left.
Supply (the amount of good a firm will sell at a certain price)
Law of supply- states that as price raises quantity supplied rises or as price falls, quantity supplied will fall.
Individual supply- supply by an individual firm of a particular good or service
Market supply- supply by all firms of a particular good or service
The supply curve- shows the relationship between prices, quantity and supply in graphical form
Factors affecting supply:
Price/cost of factors of production- reduced cost of production will result in an increase in supply
Prices of substitutes and complements- the price of other goods may encourage producers to switch to production of these goods resulting in reduced supply of the original good.
Expected future prices- this can influence the production decisions of firms. Expected rises in prices can cause firms to raise production and increase supply.
Number of suppliers- an increase in the number if sellers are likely to result in increase in supply.
Technology- new technology will lower cost of production and increase supply.
Shifts of the supply curve
Movement to equilibrium - If the prices of goods or services are higher or lower than equilibrium, disequilibrium occurs. If prices are above equilibrium, supply will be greater than demand, that is, there will be an excess of goods that are left unsold, and forcing the prices to be lower until the surplus is removed [see below diagram]. If prices are below equilibrium, the demand for a good exceeds the supply. Producers then can sell their goods for higher prices until equilibrium is reached [see below diagram].
Effects of changes in supply and/or demand on equilibrium market price and quantity through the use of diagrams
Effects of changing levels of competition and market power on price and output - If the level of competition decreases, a firm will have increased market power. This increase in market power allows them to have more influence over the market price. A firm that has no competition (a monopoly) can increase the price of a product by reducing output.
Alternatives to market solutions - the role of government
Price ceilings, price floors - The government can intervene with the prices for goods and services by placing a price floor or price ceiling. A price floor is when the government sets a minimum price for a good, whilst a price ceiling is when the government sets a maximum price for a good. A price ceiling can be set to make a good or service more accessible to the community, whilst a price floor can be placed to guarantee producers a minimum price for their output.
Market failure - situation where the market fails to allocate resources efficiently. It occurs with the provision of merit goods, public goods and externality benefits and are costs associated with the production and/or consumption of certain goods.
Merit goods, e.g. education - These are commodities, which are regarded as being socially desirable, irrespective of consumer's preferences. The merit goods of society justify the government subsidizing the provision of these goods and services.
Public goods - there are two important features of these goods. They are that i) they are indivisible in consumption (i.e. one person's consumption does not reduce the amount available, usually a non-rival or collective good) and ii) they are accessible to everyone. Public goods are usually too costly for individuals to purchase, and is usually regulated by the government.
Externalities - An externality cost is a cost, which is not, reflected in the price for a product but on other people eg pollution. A firm, which produces pollution, does not have to pay for it, nor do they sell it to consumers. Instead, communities pay for it in illnesses, loss of ability to do activities that are usually done everyday etc.
