Market

Market

Outline:

1) Introduction

2) Market

i) Supply and demand

(a) Types of goods

1. Normal goods- the law of demand applies

2. Inferior goods- as income increase demand declines

3. Giffen goods- as price increase demand also increases

(b)  Elasticity- a definition of elasticity and price elasticity

1. Demand price elasticity

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2. Supply price elasticity

ii) Types of markets

(a) Perfect competition- definition, characteristics and cost curves

(b) Monopolistic competition- definition, characteristics and cost curves

(c) Oligopoly – definition, characteristics and cost curves

(d) Monopoly- definition, characteristics and cost curves

3) Market failure:

i) Definition of market failure, sources and solutions

4) Public goods:

5) Government intervention:

6) SAFER – suggested area of further study

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7) Conclusion

8) Bibliography

Type of Markets and Their Characteristics

Abstracts:

A market is an important institution in an economy given that it facilitates trade and the allocation of resources. The paper discusses the market with reference to the law of demand, consumer and producer surplus, types of markets, market failure, public goods and government intervention. Evidence from the firms’ cost curves shows that the perfect competitive market is the most appropriate form of market, however market failure may occur and the paper highlights the importance of government intervention in eliminating negative externalities and the provision of public goods.

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Introduction:

Markets in economics can be defined as a structure that has buyers and sellers whereby both goods and services are traded. (McConnell and Brue, 128, McGraw Hill) the market is important in economics given that it facilitates trade in an economy and this enables the distribution and allocation of resources. There are various forms of markets including monopoly form of market, oligopoly, monopolistic competition and perfect competition. All these forms differ in their characteristics including the number of producers and how prices are determined in the market. (McConnell and Brue, 128, McGraw Hill press)

Supply and demand:

In perfect competitive markets the price is determined by supply and demand forces, supply refers to the quantity produced and demand refers to the quantity consumed, when demand equals to supply, (Baumol and Blinder, 61, Blackwell press)

The following diagram shows the market demand and supply:

From the above chart it is evident that the price and quantity is determined by the position of the supply and demand curve, the equilibrium price and quantity in the above case will be P and Q respectively. (Baumol and Blinder, 61, Blackwell press)The chart also identifies the consumer surplus and the producer surplus, consumer refers to benefit that the consumer receives at the given prices while producer surplus refers to the benefit received by the producer for selling at the given price. (Baumol and Blinder, 61, Blackwell press)

In some cases some goods or services are taxed by the government, government taxes yield

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government revenue but lead to dead weight loss, this can be defined as the benefit lost by both the consumers and producer, (Gregory Mankiw, 155, Prentice Hall)

The following chart demonstrates the impact of a tax on quantity supplied the price, consumer surplus and producer surplus:

From the above diagram it is evident that the impact of a tax in a market will result into deadweight loss, this is the amount of benefit that is lost by the producer and the consumer and is not recovered by the government. The price increases from p to p2 and the quantity in the market declines from q to q2. (Gregory Mankiw, 155, Prentice Hall)

Types of goods:

Normal goods:

The law of demand states that when the price of good is reduced then the demand for that good increases, however when the price of that good is increased then the demand of that good declines. (Walter Wessels, 34, Prentice Hall)This law applies to normal goods and there are other goods that do not obey this law and they include giffen and inferior goods. (Walter Wessels, 34, Prentice Hall)

Inferior goods:

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These goods do not follow the law of demand and their demand declines even when the prices of a good remains constant, these are goods whose demand declines as the income of consumers increase in the economy, as the income of consumers increase they demand more expensive goods and therefore the demand of that good declines even if its price is reduced.(Walter Wessels, 34, Prentice Hall)

Giffen goods:

These are goods whose demand increases as their prices increases, these are luxurious goods and as their price increases consumers demand more, the reason for this increase is due to the fact that consumers feel that the high price depicts high quality and also status. (Walter Wessels, 34, Prentice Hall)

Price Elasticity:

Elasticity refers to the change in quantity demanded or supplied due to changes in the price of a good. (Edward Nevin, 133, McGraw Hill press)

Supply price elasticity

Supply price elasticity refers to the change in quantity supplied. (Edward Nevin, 133, McGraw Hill press)The supply price elasticity is determined by dividing the change in quantity supplied by the change price, a value less than one means that the supply curve is inelastic while a value greater than one mean that the supply curves is elastic. (Edward Nevin, 133, McGraw Hill

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press)

Demand price elasticity

Demand price elasticity refers to the change in quantity demanded. (Edward Nevin, 133, McGraw Hill press)The demand price elasticity is determined by dividing the change in quantity demand by the change price, a value less than one means that the demand curve is inelastic while a value greater than one means that the demand curves is elastic. (Edward Nevin, 133, McGraw Hill press)

Markets:

There are four main types of markets that differ in their characteristics, they include perfect competition, oligopoly, monopoly and monopolistic competition, (McConnell and Brue, 128, McGraw Hill press)

The following is a discussion of these markets:

Perfect competition:

Perfect competitive markets are markets where we have many buyers and sellers and the price in the market is determined by demand and supply forces, in this case therefore the firms are

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price takes, (Edward Nevin, 161, McGraw Hill press)

The following are the characteristics of a perfect competitive market:

– prices are determined by supply and demand, therefore firms do not have the power to set prices in the market

– perfect information whereby consumers are producers are well informed about available goods in the market and their prices

– no entry or exit barriers whereby firm can freely enter and exit the industry

– homogenous products and this means that goods are not differentiated and therefore products are perfect substitutes

– perfect mobility of factors of production

(Edward Nevin, 161, McGraw Hill press)

Cost curves:

Having determined the characteristics of the perfect competitive market the following is a discussion of the cost curves faced by firms in perfect competition market: (Edward Nevin, 161, McGraw Hill press)

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The above chart demonstrate the cost curve faced by a firm in a competitive market, the optimal production point will be at point Q where the marginal revenue curve intersects with the marginal cost curve, therefore the firm will produce Q quantities at price P. (Edward Nevin, 161, McGraw Hill press)

Monopolistic competition:

In monopolistic competition we have many buyers and sellers but products are differentiated. (McConnell and Brue, 249, McGraw Hill press)

Characteristics include

– many producers

– products are differentiated

– no entry or exit barriers

– perfect information

– mobility of factors of production

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(McConnell and Brue, 249, McGraw Hill press)

Oligopoly:

Oligopoly form of market comprises of a few sellers or firms, this form of the market has the following characteristics: (Baumol and Blinder, 241, Blackwell press)

-A few producers:

-Entry barriers: this refers to set barriers that do not permit other firms to enter the industry, these barriers include

-Homogenous goods or services

-Perfect information

(Baumol and Blinder, 241, Blackwell press)

Monopoly:

This refers to a form of market where there exists only one producer in the market, in this case therefore the firm sets the price; (Walter Wessels, 404, Prentice Hall)

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The following are the characteristics of a monopoly form of market:

– only one producer in the market

– the firm sets the price in the market

– entry and exit barriers

(Walter Wessels, 404, Prentice Hall)

The following shows the cost curves of the monopolistic firm:

The above diagram shows the cost curves of the monopoly firm, the firm will charge a higher price P and the quantity produced will be less than in the case where we have a perfect competitive market. (Edward Nevin, 199, McGraw Hill press)

Market failure:

Market failure refers to a situation whereby the market does not allocate resources effectively, market failure occurs due to various reasons which include imperfect information whereby consumers may not be aware of existing technology, advertisements that may mislead consumers and when producers are not aware of existing opportunities in the market. (Gregory

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Mankiw, 131, Prentice Hall)

The other reason for the existence of market failure is differentiation of goods whereby products in the market are braded and have different prices, the consumer may associate the price with quality and this may not be the case applied by the producers. Market power is also a source of market failure whereby this may lead to barriers to entry of firms and the existence of monopolies that produce less than the market demands. (Gregory Mankiw, 131, Prentice Hall)

The other reason why market failure occurs is the existence of external costs and benefits, this occurs when the production process leads to other external costs or benefits that are not accounted for when pricing goods and services, a good example is a production process that does not take into account environmental degradation such as pollution. (Walter Wessels, 532, Prentice Hall)

Market failure can be resolved using various policy measures and they include taxation, in cases where the market leads to external costs then taxation can be applied so that the price of goods and service accounts for the negative externality. For positive externalities a subsidy can be offered. (Walter Wessels, 532, Prentice Hall)The other policy measure is to prohibit the production of goods and services that lead to negative externalities. Finally the government may choose to regulate the market whereby the government may discourage the existence of monopolies in the market.

Public goods:

In the market there are those goods that are referred to as public goods, these goods are provided by the government due to various reasons, the reasons why the government provide these goods is because the provision of these goods is too expensive for firms to provide. (Baumol and Blinder, 316, Blackwell press) Also due to the fact that the provision of these

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goods by firms may not yield economic profits and the government will source revenue from taxes in order to provide public goods (Walter Wessels, 551, Prentice Hall)

Public goods include products such as roads, railway roads and education. The government will provide these gods given that they require huge investment and the returns are relatively low. (Baumol and Blinder, 316, Blackwell press)However problems arise whereby the market may exhibit the free rider effect, this refers to the situation whereby some individuals in the economy do not pay taxes yet they enjoy public goods, therefore it is evident that the market cannot function without public goods and therefore the role of the government in the market is to provide public goods. (Baumol and Blinder, 316, Blackwell press)

Government intervention:

Economists advocate for a free market economy, this means that there should be no interventions by the government because this only makes things worse, some others state that the government should intervene in the operations of the economy. (Walter Wessels, 551, Prentice Hall)There exist arguments for and against the role of government intervention in the free market economy, some economist’s state that the government has a role in the provision of public goods, eliminating market failure and formulation of policies that ensure the smooth running of the economy.

Other economists such as Milton Friedman state that government intervention only makes situation worse, according to him government intervention example expansionary policy measures will take time to impact the economy and therefore the time lag will prolong problems faced by the economy. (McConnell and Brue, 307, McGraw Hill press)The other reason he givens is that the decisions on government intervention may be influenced by the political environment and therefore policy measure may not be undertaken to improve current problems in the economy but may be aimed at shaping the opinion of the masses. (McConnell and Brue, 307, McGraw Hill press)

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Bibliography:

Campbell McConnell and Stanley Brue. Microeconomics: principles, problems, and policies.

New York: McGraw Hill press, 1999.

Edward Nevin. An introduction to micro economics. New York: McGraw Hill press, 2004.

Gregory Mankiw. Principles of microeconomics. New Jersey: Prentice Hall press, 2002.

Walter Weasels. Economics, New Jersey: Prentice Hall press, 2001.

William Baumol and Alan Blinder. Economics: Principles and Policy. New York: Blackwell press, 1999.

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