MICROECONOMICS
TOPIC 4
Economics 2013/2014
THE OPERATION OF MARKETS
WHAT IS A MARKET?

This is a place where buyers and sellers come
together to exchange goods and services for a
price.
FREE MARKET

This is a market that has:
 No
barriers to entry
 Price is set in the market by demand and supply, firms
accept this price
 No government intervention
EQUILIBRIUM PRICE



Price in a free market is called the equilibrium
price.
It is where demand and supply are equal.
The market is cleared, no unsold stock (surplus) or
unhappy customers (shortage). Can be called the
MARKET CLEARING PRICE.
Equilibrium Price
Price
D
SURPLUS
S
P1
P
P2
SHORTAGE
D
S
Q
Quantity



At P1, the market is not in equilibrium. Suppliers are
willing to supply more than customers wish to buy.
This creates excess supply/surplus in the market.
Firms will have to cut production and lower their
price in order to get rid of the excess stock



At P2, customers wish to buy more of the product
than suppliers wish to supply.
There is excess demand/shortage in the market.
Consumers will compete with each other for what is
available by offering a higher price and suppliers
will produce more.


At P there is no upward or downward pressure on
price
The market is in equilibrium.
CHANGES IN PRICE


Equilibrium price will only change if there is a
change in a condition of demand or supply.
Please note there could be a change in both.


An increase in demand, a shift to the right, will lead
to a rise in price,
A decrease in demand, a shift to the left, will lead
to a fall in price.
Change in Condition of
Demand
D1
Price
D
S
P1
P
D1
D
S
Q
Q1
Quantity


An increase in supply, a shift to the right, will lower
price
An decrease in supply, a shift to the left, will
increase price.
Change in Condition of
Supply
Price
D
S
S1
P
P1
S
D
S1
Q
Q1
Quantity
REMEMBER!!!

In the exam if a question talks about the price in a
market, you must draw a market graph, i.e. have
demand and supply curves in it.
INTERVENTION IN A FREE MARKET
1.

Setting a minimum price
This is when the government feels that the price in
the market is too low.

A minimum price is set above the equilibrium price.

However, it can create a surplus in the market.
MINIMUM PRICE
Price
D
S
MINIMUM PRICE
P
D
S
Q
Quantity
EXAMPLES OF MINIMUM PRICE


The Common Agriculture Policy of the EU. Set a
minimum price for agricultural products produced in
the EU.
The setting of the Minimum Wage for low paid
workers. Can however create unemployment.
2.



Setting a Maximum Price
The government sets a price below equilibrium price
when it feels the market price is too high.
This may have been done to help low income
consumers or part of an anti-inflation strategy.
It can lead to a black market due to excess demand
in the market.
MAXIMUM PRICE
Price
D
S
P
MAXIMUM PRICE
D
S
Q
Quantity
3.



Imposing Expenditure Taxes
This has the same affect as an increase in cost of
production.
Producers will raise their selling price in order to
covered the increased cost. Supply will shift to the
left and a new equilibrium price will be determined.
How much they can pass on to the consumer
depends on the elasticity of demand.
4.
Giving Subsidies

This has the opposite affect of a tax.


Given to encourage supply and lower prices. E.g.
rural bus services
It reduces cost of production and therefore lowers
price and shifts supply curve to the right.
5.


Quota
This is when the government intervenes and
restricts the number of products supplied to the
market.
For example fishing quotas that limits how much
fish can be caught.
QUOTA
QUOTA
Price
D
S
P1
P
D
S
Q
Quantity