Chapter 4

Chapter 4 – The Market System

Characteristics of the Market System

Private Property – In a freemarket system capital is privately owned

Property ownership encourages investment, innovation, exchange, maintenance of property and economic growth because it is in their best interests because they will reap the rewards

Private Property is also in the form of copyrights, Property rights facilitate exchange (ie property deeds)

Freedom of Enterprise and Choice

Freedom of Enterprise – lets entrepreneurs produce and sell their products

Freedom of Choice – enables owners to do whatever they want with their capital, for workers to work wherever they want to, and for consumers to buy whatever the fuck they want

Self Interest

Everyone is trying to do as well for themselves as they can (entrepreneurs, workers and consumers)

Competition – Freedom of choice exercised in the pursuit of economic gain

Independently acting sellers and buyers and the freedom of these sellers and buyers to enter/leave markets creates competition

When there are many buyers/sellers nobody controls market prices

Nobody can “rig the market” by monopolizing on supply/demand

The diffusion of economic power inherent in competition limits the potential abuse of that power

Markets and Prices – A vast network of communication that governs supply and demand

Reliance on Technology and Capital Goods – innovation promises to earn money for the developer

Roundabout Production – Not direct production ie someone doesn’t build a car with their bare hands they use machines, economy of scale etc

Specialization

Much more efficient to have someone produce only one component of a larger product/service (ie someone who only installs roofing rather then jack of all trades)

Division of Labor – in order to facilitate specialization

Makes use of differences in ability – some people are better suited to be doctors then others

Fosters learning by doing – because someone does the same thing constantly they have a greater opportunity to develop skills

Saves time – no need to constantly shift jobs

Geographic Specialization

Many areas are much better suited to a particular industry, for example Oranges aren’t grown in New York

Also internationally it makes sense to export one good in exchange for another, ie USA exports Airplanes and imports bananas from Honduras

Use of Money

 Money is a medium of exchange, a convenient medium of exchange allows for greater specialization because bartering relies on a coincidence of wants between the two traders.  For example if you are trading Corn for a car, the car seller must need corn and you must need a car

Money must be universally acceptable to the sellers in exchange for goods and services

Active but limited Gov’t

While gov’t serves to limit the free market economy, it can also increase the overall efficiency of the economy

The Market System at Work

THE FOUR FUNDAMENTAL QUESTIONS

1.       What goods and services will be produced? – Because businesses seek profits and avoid losses, the goods and services produced at a continuing profit will be produced and those produced at a continuing loss will be not… Economic Profit = Total revenue – total costs

a.       Economic Costs are the payments that must be made to secure and retain the needed amounts of those resources

b.       The Cost of the entrepreneurs contribution is called the normal contribution

c.       Revenue – total economic costs is the economic profit (aka pure profit) which goes to the entrepreneur

d.       A positive economic profit is the mark of a successful industry – one that will likely become an expanding industry otherwise its called a declining industry

e.       Consumer Soverignity – consumers are soverign (in command) in the market system because they control what is bought and therefore what is sold

                                                                           i.      Dollar votes – when a consumer buys a good/service, they are “voting” with their dollar for a particular industry, thus controlling demand

f.        Market Restraints on Freedom

                                                                           i.      Firms produce have to produce what consumers demand or they’ll go bankrupt

                                                                         ii.      The demand for resources is a derived demand (derived from the demand for the goods they are used to produce)

2.      How will these goods be produced

a.       Market system steers resources towards profitable industries b/c they can afford them

b.       The most efficient production technique depends on the available technology and the prices of the required resources

3.      Who will get these goods and Services

a.       Distributed based on consumers ability and willingness to pay for goods

b.       The amount of income they have (their ability to purchase items) depends on how much property/human resources they can supply and the value of those resources on the market

4.      How will the system accommodate change

a.       Must economize to a specific pattern of consumer tastes, technological resources and amount of resources

b.       Guiding function of prices – As consumer preferences change, self interest will cause entrepreneurs to join the market for popular products and encourage the decrease of the depressed industry

c.       Higher prices allow producers to pay higher prices for resources and expand the business

d.       Guiding function of prices – prices that are changed by consumer demand allow for the expansion/depression of markets, this results in changes the flow of resources to various markets

Role in Promoting Progress – How does the market prompote technological improvements and capital accumulation-which lead to greater efficiency, higher productivity and a higher level of economic well-being.

Technological Advance – strong incentive b/c it results in a revenue increase w/o needing to increase demand

The market system is conducive to rapid spread of technology through an industry

Creative Destruction – the creation of new products and production methods destroys the market positions of old goods or services

Capital Accumulations – Entrepreneurs often put some of their profits towards technological innovation

Competition and the Invisible hand

The invisible hand is from Adam Smith’s 1776 book the wealth of nation, it represents self interests

                The operation of a market system creates a unity between private interests and social interests.  By being efficient, producing revenue, the self interest of businesses translates into the welfare of the people

Competition controls and guides self-interest

Market system – Facilitates

Efficiency – efficient use of resources, incentive for technological advancements, organizes resources for production

Incentives – encourages skill acquisition, hard work and innovation.  Entrepreneurship is highly profitable, leading to innovation and greater work skills lead to a higher standard of living

Freedom – personal freedom allows people to further their own self interest, therefore aiding society as a whole

Chapter 3

Chapter 3 – Individual Markets: Demand and Supply

Markets – an institution or mechanism that brings together buyers and sellers of particular goods, services and resources

Markets come in many forms – stores, NYSE, labor markets (buy and sell labor ie hiring process)

In the stock market or grain exchange the price is discovered based on supply and demand instead of being set by a company

Demand – A schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time

Demand Schedule – an estimation of how much of a product would sell based on the price in a specified time period

Law of Demand

As prices fall the quantity demanded increases as long as everything else is equal. For example if the Prices of Nikes fall but Adidas and Asics fall too then the demand will not be affected greatly. More dependent on the relative price of goods

Diminishing marginal utility – during a specific period, successive purchases of the same item yield less and less utility… ie if you have one car and you buy another one, the second car is less intrinsically useful than the first one because if you didn’t have the first car you couldn’t drive anywhere

Law of increasing opportunity costs – Have to give up more as you add more

Income effect – a dumb little principle that says the cheaper shit is the more of it you can buy with your income by increasing the purchasing power

Substitution effect – a lower price causes a buyer to substitute a cheap product for a more expensive one

Demand curve - a graph that compares price with quantity demanded

Market Demand

The market for each product can be determined by seeing the cost/demand relationship in a sample of consumers and extrapolating for a whole market

Determinations of demand – cost is usually the determinant of demand, things that effect demand are called demand shifters

An overall increase in demand shifts the demand curve to the right

Consumer preferences - A favorable change in consumer tastes for a product increases demand – shifts demand curve to the right…ie consumers start to prefer DVD players over VHS

Number of Consumers

The Prices of Goods

Income – Richer people tend to buy more superior goods (Ferrari, Godiva) rather than normal goods (fords, hershey’s) Goods whose demand varies inversely with income are called INFERIOR GOODS (ie old shitty used cars, retreads, charcoal grills (people opt for gas instead))

Prices of related goods – some goods influence each others sales

Substitute good – one that could be used in place of another one (ie gas grill instead of charcoal grill, as gas grill sales go up, charcoal sales go down). Also specific brands can be considered substitutes like reebok for nike. Substitution in consumption occurs when the price of one good rises relative to the other good

Complementary good – a good that is used with another good

Unrelated goods – duh

Expectations – A lot of times people would try to anticipate the price of a good later and either buy a lot of that good or less of that good. Ie when people thought that gas was going to raise to over 5 dollas a gallon a lot of people filled up barrels of gas so demand increased

Changes in Quantity demanded

Change in demand – shift of the demand curve either left or right – occurs when consumers are convinced by one or more of the determinants of demand

Change in quantity demanded – when a price (or some other factor) causes the quantity demanded to change but does not cause a change at all levels of demand. Ie over the past few years, chicken prices have skyrocketed so the quantity demanded is less than it once was

Supply – a schedule or cuve showing the amount of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period

Supply schedule – much like a demand schedule, a supply schedule shows at certain prices how much suppliers will produce

Law of Supply – As prices rises the quantity supplied rises as price falls, the quantity supplied falls

To a supplier price represents revenue – the more potential for higher revenue (bc of higher prices) the more incentive for the supplier to supply

Manufacturers usually have increasing marginal costs (the cost to produce one more unit) this is because factory size is limited so producers would have to build more factories or have more workers with fewer resources

The supply curve – pretty self explanatory – the relationship between price/unit and the quantity produce

Determinants of Supply – Much like price isn’t the only determinant of supply for demand, it isn’t the only determinant of supply either

Resource Price – higher resource prices raise the cost of production – thus squeezing profits and reduce the incentive to produce a lot of something. (b/c as price increases, demand decreases)

Technology – improvements in technology allow suppliers to produce products more efficiently (at a lower price)

Taxes and Subsidies – an increase in sales/property taxes or specialty taxes (gas tax, cig tax, alcohol tax) decreases the incentive for vast production, subsidies (such as the ones given to attract a factory to an area) increase the incentive to produce more goods

Prices of other goods – substitution in production causes the original products price to rise, so there may be a substitution back

Price expectations – If a producer expects product prices to rise later, they may produce more

Number of Sellers – If there are more suppliers there is more supply

Changes in quantity supplied

Diff from “a change in supply” in that it represents a shift from points in the curve rather than shifting the curve

This would be a result of a change in price if all other things were equal

Supply and demand: Market Equilibrium

Surpluses – It is unwise for a supplier to supply more than the market demands but if it happens then prices will plummet

Shortages – price will increase such that the demand is equal to the supply

Equilibrium Price and Quantity – the price naturally shifts such that demand is equal to supply, establishes an equilibrium price and quantity

Graphically the intersection of the supply curve and the demand curve is the market equilibrium price

Rationing Function of Prices

The process by which market equilibrium is established. It is the combination of freely made individual decisions that makes sure that the market clears

Changes in Supply, Demand and Equilibrium

Changes in Demand – If Demand is increased, then the intersection of the demand/supply curve is greater in price and quantity

Changes in supply – likewise if supply is increased, the price decreases although the quantity increases

Complex cases

Supply Increase, demand decrease – both changes decrease the price so overall the prices plummet If supply is larger than the decrease in demand the equilibrium quantity will increase and vice-versa

Supply Decrease; Demand increase – A decrease in supply and increase in demand both increase demand so put together they increase the price a lot. If the decrease in supply is greater than the increase in demand the equilibrium quantity will decrease

Supply decrease, demand Decrease – If the decrease in supply is greater than the decrease in demand, equilibrium price will fall

REMEMBER TO KEEP ALL OTHER THINGS EQUAL

Gov’t Set Prices

Price Ceilings and Shortages – the maximum legal price a seller may charge for a product or service, these are established because the equilibrium prices would be unaffordable otherwise. Also limits on interest rates protect consumers from extreme usury

Graphical Analysis – To make an impact, ceiling prices must be below equilibrium point, Price ceiling P prevents the usual market adjustment

Rationing Problem – In a shortage created by a price ceiling, the gov’t could offer rations

Black Markets – There would be a huge black market that would develop for people willing to pay the price warranted by the actual demand

Rent Controls – Goal to make housing available for the poor, often discourage the supply of rental properties such that a housing shortage is created

Price Floors and Surpluses – when gov’t thinks that the minimum price is not enough to sustain those who supply a product

For example: Minimum wage and minimum agriculture prices

There will always be a surplus because farmers supply more than the quantity demanded at a raised price. Although it may seem that the supply would adjust such that there was no surplus, for individual farmers there is an incentive to produce more than they should as part of the whole

The gov’t copes with the surplus – restrict supply by limiting the amount of land that can produce the crops or increase demand by looking for other uses for the product (ie see what else can be done with wheat) The gov’t could also buy up the surplus, therefore subsidizing the farmer (this comes from taxes – no free lunch!)

Also this causes the products to cost more for the consumers and encourages irrational proportioning of production towards the production of these goods