The workings of the Market

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The workings of the Market
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Objectives

• Understand the way in which markets and function
  and how this helps us to allocate scarce
  resources
• Understand how prices are determined in
  competitive markets
• Start thinking put how we can apply the
  principles of demand and supply to policy issues
• Consider why some markets work more effectively
  than others
• Assess the effectiveness of government policy

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Prices and Values

• The diamond / water paradox

1.50 / kg
40 million/ kg
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Marginal Values

• The extra benefit you get from one more unit of
  something is called its marginal utility
• Think of beer / wine / chocolate / pizza...

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Price and the Concept of the Margin

• The concept of the margin is a central concept
  in economics
• A consumer will be willing to pay a price up to
  the marginal benefit that they get from a product
• A producer will be willing to supply something up
  to the point where producing an extra (marginal)
  unit makes them no extra profit

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Why do Prices Matter?

• Ration scarce resources
• Provide signals to producers
• Directly affect quality of life

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What Determines a Price?

• Consider the market for alcohol
• Which factors determine the price?
• What about the housing market?
• Or the market for petrol?
• Economists use a model of demand and supply to
  explain the functioning of a market and the
  factors that cause prices to rise and fall

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The determination of market equilibrium
(potatoes monthly)
E
e
Supply
d
D
c
C
Price (pence per kg)
b
B
a
A
Demand
Quantity (tonnes 000s)
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The Degree of Competition

• Classifying markets
• number of firms
• freedom of entry to industry
• nature of product
• nature of demand curve
• The four market structures
• perfect competition
• monopoly
• monopolistic competition
• oligopoly

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Features of the four market structures
Structure ? conduct ? performance
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The Behaviour of Firms

• How do firms actually set prices?
• What are the objectives of firms?
• The Divorce of ownership from control
• How can we assess whether firms are acting in the
  public interest?
• Is there a role for the government?

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Starting to Think About Policy

• For one of the policy areas below, identify
• why government might be concerned about prices
• what the main drivers of prices are in the market
  (both demand and supply)
• what government policy could do to tackle the
  issues
• what might be some unintended consequences and
  political trade-offs?
• Binge drinking
• Obesity
• First-time buyers priced out of housing market
• Petrol
• Energy

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Market Failure

• When markets allocate resources efficiently,
  there may be no need for governments to intervene
• When we make decisions, we normally take into
  account the costs and benefits to ourselves
• We ignore the costs and benefits to society
• Social Efficiency allocative efficiency
• marginal social costs and benefits
• social efficiency achieved where MSB MSC
• If the wrong amount is produced or consumed,
  there is justification for government intervention

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Sources of Market Failure

• Imperfect Competition i.e. monopoly power
• Externalities
• Imperfect information
• Missing markets including public goods
• The time dimension
• The principalagent problem
• Protecting people's interests
• dependants
• poor economic decision making by people
• merit goods and demerit goods

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Market Failures Monopoly Power

• Why is a monopoly bad?
• What can governments do if a monopoly exists?

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Market Failures Externalities

• Externalities arise where there are
  costs/benefits that are not accounted for in the
  market mechanism
• Externalities may be negative or positive
• Externalities may be associated with production
  or with consumption
• Production
• MSC gt MPC

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Negative externalities in production
Costs and benefits
P1
O
Quantity
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Negative externalities in production
MSC
Costs and benefits
P2
P1
D MPB MSB
O
Quantity
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Market Failures Externalities

• Externalities arise where there are
  costs/benefits that are not accounted for in the
  market mechanism
• Externalities may be negative or positive
• Externalities may be associated with production
  or with consumption
• Consumption
• MSB gt MPB

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Positive externalities in consumption
S MSC
Costs and benefits
P1
O
Q1
Quantity
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Positive externalities in consumption
S MSC
P2
Costs and benefits
P1
MSB
O
Q1
Quantity
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Market Failures Externalities

• How might a government intervene if faced with an
  externality?

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Market Failures Public Goods

• Public goods are defined as goods with the
  following characteristics
• non rivalry
• non-excludability
• What is the problem with a public good and why is
  there a role for government?
• Can you relate this back to the topic of game
  theory and the Nash equilibrium?
• Why do we have a tax system that redistributes
  from rich to poor?
• The Warm Glow Effect

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• Taxes and subsidies
• Laws and Regulation
• Changes in property rights
• Provision of information
• Financial intervention
• Direct Provision of goods and services
• Should there be more or less intervention in the
  market?

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• How well would this market function if there was
  no government intervention?
• Would there be justification for intervention
  based on efficiency grounds?
• Would there be a justification for the government
  to intervene because of equity?
• What type of intervention would be the most
  effective?
• Comparing different healthcare systems

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