Explain the Workings of Market Mechanism
23 November 2009 Business Environments Assignment #1
Explain the workings of market mechanism. What can cause markets to fail?
Economists have to deal with a range of economic problems when studying an economy. But the basic economic problem is:
“Scarce resources in relation to unlimited wants” – Bamford, 2001
Because there are unlimited wants and limited resources, societies have to confront three basic questions
What to produce? Everything cannot be produced so we need to decide what goods should be produced and in what quantities. Here comes the concept of Opportunity Cost .
How to produce? Economics demands the most efficient use of resources, hence the concept of economic efficiency was introduced. Here we need to consider how we can get the maximum use out of the given resources and use them efficiently.
For whom to produce? Because of scarce resources, all wants cannot be satisfied so again choices need to be made. A market is where buyers and sellers interact to exchange goods and services.
“The essence of any market is trade. So, whenever people come together for the purposes of exchange or trade, we have a market.” - Bamford, 2001
These markets work on the basis of demand and supply. Demand refers to the quantities of a product that consumers are willing and able to buy at a given price, ceteris paribus.
Demand Curve.
Price
40
30
20
Quantity
D
40
80
60
The diagram shows that there is an inverse and causal relationship between price and quantity demanded.
P QD
P QD
Price is one determinant of demand. Others include changes in tastes and fashion, prices of substitutes and complements and expectations of further price changes. Changes in these factors cause shifts in the demand curve. A rightward shift indicates an increase:
Price
P 2
P 1
D 1
D 2
Q 2
Q 1
Quantity
Price
A leftward shift indicates a decrease:
P 1
P 2
D 2
D 1
Q 1
Q 2
Quantity
Price
S
Supply
Explain the workings of market mechanism. What can cause markets to fail?
Economists have to deal with a range of economic problems when studying an economy. But the basic economic problem is:
“Scarce resources in relation to unlimited wants” – Bamford, 2001
Because there are unlimited wants and limited resources, societies have to confront three basic questions
What to produce? Everything cannot be produced so we need to decide what goods should be produced and in what quantities. Here comes the concept of Opportunity Cost .
How to produce? Economics demands the most efficient use of resources, hence the concept of economic efficiency was introduced. Here we need to consider how we can get the maximum use out of the given resources and use them efficiently.
For whom to produce? Because of scarce resources, all wants cannot be satisfied so again choices need to be made. A market is where buyers and sellers interact to exchange goods and services.
“The essence of any market is trade. So, whenever people come together for the purposes of exchange or trade, we have a market.” - Bamford, 2001
These markets work on the basis of demand and supply. Demand refers to the quantities of a product that consumers are willing and able to buy at a given price, ceteris paribus.
Demand Curve.
Price
40
30
20
Quantity
D
40
80
60
The diagram shows that there is an inverse and causal relationship between price and quantity demanded.
P QD
P QD
Price is one determinant of demand. Others include changes in tastes and fashion, prices of substitutes and complements and expectations of further price changes. Changes in these factors cause shifts in the demand curve. A rightward shift indicates an increase:
Price
P 2
P 1
D 1
D 2
Q 2
Q 1
Quantity
Price
A leftward shift indicates a decrease:
P 1
P 2
D 2
D 1
Q 1
Q 2
Quantity
Price
S
Supply
Bibliography: * Bamford, Bruskill, Cain, Grant, Munday & Walton, Economics * M Parkin, M Powell et al Economics 7th edition * J Sloman Economics 4th edition * http://www.lse.co.uk/financeglossary.asp?searchTerm=&iArticleID=2126&definition=market_structure * http://en.wikipedia.org/wiki/Economic_equilibrium