Lesson 4: Markets in Action
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|Demand||Supply||Market clearing price|
|Competition||Exchange||Price ceilings & floors|
|Property rights||Marginal analysis|
National Content Standards Addressed
Standard 8: The Price System
Prices send signals and provide incentives to buyers and sellers. When supply or demand changes, market prices adjust, affecting incentives.
- Higher prices for a good or service provide incentives for buyers to purchase less of that good or service and for producers to make or sell more of it. Lower prices for goods or services provide incentives for buyers to purchase more of that good or service and for producers to make or sell less of it.
- An increase in the price of a good or service encourages people to look for substitutes, causing the quantity demanded to decrease, and vice versa. This relationship between price and quantity demanded, known as the law of demand, exists as long as other factors influencing demand do not change.
- An increase in the price of a good or service enables producers to cover higher per-unit costs and earn profits, causing the quantity supplied to increase, and vice versa. This relationship between price and quantity supplied is normally true as long as other factors influencing costs of production and supply do not change.
- Demand for a product changes when there is a change in consumers’ incomes or preferences, or in the prices of related goods or services, or in the number of consumers in a market.
- Supply of a product changes when there are changes in the prices of the productive resources used to make the good or service, the technology used to make the good or service, the profit opportunities available to producers by selling other goods or services, or the number of sellers in the market.
- Changes in supply or demand cause relative prices to change; in turn, buyers and sellers adjust their purchase and sales decisions.
Standard 9: Role of Competition
Competition among sellers lowers costs and prices, and encourages producers to produce more of what consumers are willing and able to buy. Competition among buyers increases prices and allocates goods and services to those people who are willing and able to pay the most for them.
- Competition among sellers results in lower costs and prices, higher product quality, and better customer service.
- The level of competition in a market is influenced by the number of buyers and sellers.
- The level of competition in an industry is affected by the ease with which new producers can enter the industry and by consumers’ information about the availability, price, and quantity of substitute goods and services.
- Collusion among buyers or sellers reduces the level of competition in a market. Collusion is more difficult in markets with large numbers of buyers and sellers.
Standard 16: Role of Government:
There is an economic role for government to play in a market economy whenever the benefits of a government policy outweigh its costs. . . .
- In the United States, the federal government enforces antitrust laws and regulations to try to maintain effective levels of competition in as many markets as possible; frequently, however, laws and regulations also have unintended effects – for example, reducing competition.
Standard 17: Public Choice
Costs of government policies sometimes exceed benefits. This may occur because of incentives facing voters, government officials, and government employees, because of actions by special interest groups that can impose costs on the general public, or because social goals other than economic efficiency are being pursued.
- Price controls are often advocated by special interest groups. Price controls reduce the quantity of goods and services consumer, thus depriving consumers of some goods and services whose value would exceed their cost.
- In open markets, prices moving freely in response to changes in supply and demand allocate resources to their most highly valued uses.
- Market equilibrium, the condition where quantity supplied equals quantity demanded, emerges from the predictable responses of buyers and sellers to price incentives.
2. Institutions establish the rules of the game under which markets operate. Government(s) may create or affect institutional arrangements.
- Government actions that support the effective operation of open markets include such important activities as enforcing the rule of law and defining and protecting property rights.
- Government actions that reduce the openness of markets inhibit the ability of price incentives to allocate resources to their most highly-valued uses.
- Examples of changes in the rules of the game that inhibit markets include restrictions on price levels or on the conditions of production, sale, and consumption.
- Controls that prevent prices from rising to an equilibrium result in shortages
- Controls that prevent prices from falling to an equilibrium result in surpluses.
- Regulations, such as licensing, production regulations, and quality specifications reduce supply and increase prices.
- Government actions that are well-intentioned often produce unintended consequences such as “black markets” to allocate goods, or impacts on other markets that were not the target of the actions.
3. Understanding how prices act as incentives that influence people’s choices allows us to predict and explain the results of government actions that restrict the operation of markets.
- Price controls lead to shortages (price ceilings) and surpluses (price floors).
- Restrictions on competition, regulations, and subsidies reduce quantities sellers offer in the market and raise prices to buyers.
4. Economists conceptually organize the apparent chaos of markets by using the supply and demand model.
- Review: Law of demand and law of supply introduced in Lesson 2.
- Demand – people’s willingness and ability to buy – is affected by such factors as tastes, incomes, and the price and availability of substitutes and complements.
- Supply – producers’ and sellers’ willingness and ability to offer products for sale – is affected by such factors as availability of resources and production cost; the number of sellers; and the prices of other products.
- Prices coordinate market activity by providing incentives to buyers and sellers to act so that both gain from trade.
5. Equilibrium (market clearing) prices emerge from the interactions of demanders and suppliers in markets and provide incentives that shape buyers’ and sellers’ future choices.
- If sellers offer more than buyers are willing to purchase at the current price, inventories accumulate and the market receives a signal that price is too high.
- If buyers cannot purchase all that they demand or cannot find certain goods at the current price, the market receives a signal that price is too low.
- The inventory and purchase signals move price in the direction of an equilibrium price, or market clearing price, where quantity demanded equals quantity supplied.
6. Markets function most effectively when prices move freely in response to changes in supply and demand. Institutional support for markets, in the form of clearly defined property rights and the rule of law, facilitate the free movement of prices.
7. Market power results from successful efforts to reduce competition.
- (Option: Re-run the “In the Chips” activity with limited seller competition.)
- Economic growth is restricted when competition is reduced in a market.
Ideas To Take Away From This Lesson
- Open markets benefit both buyers and sellers by providing a low cost mechanism in which they can trade with each other.
- Open markets encourage economic growth.
- Open entry and exit and competition between participants are necessary for markets to function effectively.
- Clearly defined property rights and a stable rule of law are necessary for markets to function at low cost to participants.