Chapter 13 - Markets
The role of a market
There are three main types of actor or agent in the market system. Consumers and producers
interact in the goods markets of the economy. Producers and the owners of the factors of
production interact in the factor markets of the economy.
The main actors in the market
Owners of CELL
In a pure free market
economy, it is the consumer
who is all powerful. It is
assumed that consumers will
allocate their scarce
resources so as to maximise
their welfare, satisfaction or
In a pure free market
economy firms are the
servants of the consumer.
They are motivated to
maximise the difference
between revenue and costs.
These are motivated to
maximise their returns from
their land, labour and
The function of prices in the market
Rationing – One function of price in a market is to allocate and ration scarce resources. If many
consumers demand a good, but its supply is relatively scarce, then prices will be high.
Signalling – Prices come about because of the transactions of buyers and sellers. They reflect
market conditions and therefore act as a signal to those in the market. Decisions about buying
and selling are based on those signals.
Incentive – Prices act as an incentive for buyers and sellers. Low prices encourage buyers to
purchase more goods. On the supply side, higher prices encourage suppliers to sell more to the
Chapter 14 – Economic efficiency
Allocative or economic efficiency – occurs when resources are distributed in such a way that
no consumers could be made better off without other consumers becoming worse off.
Dynamic efficiency – occurs when resources are allocated efficiently over time.
Market failure – where resources are inefficiently allocated due to imperfections in the
working of the market mechanism.
Productive efficiency –when production is achieved at the lowest cost.
Static efficiency – occurs when resources are allocated efficiently at a point in time.
Technical efficiency – is achieved when a given quantity of output is produced with minimum
number of inputs.
Efficiency is concerned with how well resource, such as time, talents or materials, is used to
produce an end result.
Static efficiency exists at a point in time. An example of static efficiency would be whether a
firm could produce 1 million cars a year more cheaply by using more labour and less capital.
Dynamic efficiency is concerned with how resources are allocated over a period of time.
Productive efficiency exists when production is achieved at lowest cost.
Economic efficiency is concerned with whether resources are used to produce the goods and
services that consumers wish to buy.
Market failure
Market failure occurs when markets lead to an inefficient allocation of resources. Factors that
can lead to market failure are:
Lack of competition in a market: Firms which dominate their markets, for instance, will
attempt to change high prices in order to make higher profit.
Externalities: When the market is putting out the wrong signals, leading to a misallocation of
Missing markets: Some goods such as public goods will not be provided by the market. Other
goods, called merit goods will be under provided.
Information failure: When both the supplier and the buyer do not have the same amount of
information about the product. This is called asymmetric information.
Factor immobility: When the factors of production are immobile, this means that they are
difficult to transfer from one use to another.
Inequality: Market failure can also be caused by inequality in the economy. This will occur if
wealth is badly shared.