as/a2 applying economic theory the theory of markets and the real world with illustrations from the...

AS/A2 Applying economic theoryAS/A2 Applying economic theory

The theory of markets and the real worldWith illustrations from the

housing, energy andfood retailing markets

The theory of markets and the real worldWith illustrations from the

housing, energy andfood retailing markets

AS AQA Edexcel OCR

1 Markets and market failure Markets – how they work The market system

2 The national economy Markets – why they fail Market failure and government intervention

3 Markets at work Managing the economy The national and international economy

A2 AQA Edexcel OCR

1 Working as an economist Industrial economics

2 Business economics and the distribution of income

a. Labour economics: or b. Development economics

Two from a. Economics of work

and leisure b. Transport economics c. Economics of

Development d. The UK economy

3 Government policy, the national and international economies

The UK in the global economy

Economics in a European context

Efficiency

of Markets

Efficiency

of Markets

AS/A2 Applying economic theoryAS/A2 Applying economic theory

Efficiency of marketsEfficiency of markets

• Responsiveness to consumer wishes– price elasticity of supply

• factor mobility• flexibility of work practices• time period

• Responsiveness to consumer wishes– price elasticity of supply

• factor mobility• flexibility of work practices• time period

Supply curves with different price elasticity of supplySupply curves with different price elasticity of supply

P

Q O

P0

Q0

S1

S2

D0

D1

Q2 Q1

P2

P1

Efficiency of marketsEfficiency of markets

• Responsiveness to consumer wishes– price elasticity of supply

• factor mobility• flexibility of work practices• time period

– the case of housing

• Responsiveness to consumer wishes– price elasticity of supply

• factor mobility• flexibility of work practices• time period

– the case of housing

-10

-5

0

5

10

15

20

25

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

House price InflationHouse price Inflation

Efficiency of marketsEfficiency of markets

• Responsiveness to consumer wishes– price elasticity of supply

• factor mobility• flexibility of work practices• time period

– the case of housing

• Responsiveness to consumer wishes– price elasticity of supply

• factor mobility• flexibility of work practices• time period

– the case of housing : shifts in demand• income

• rates of interest

• availability of mortgages

• mortgage tax relief

• desire for home ownership

• return on investment in housing

• speculation about future house prices

: shifts in demand• income

• rates of interest

• availability of mortgages

• mortgage tax relief

• desire for home ownership

• return on investment in housing

• speculation about future house prices

Efficiency of marketsEfficiency of markets

• Responsiveness to consumer wishes– price elasticity of supply

• Responsiveness to consumer wishes– price elasticity of supply

• Responsiveness to changes in supply– price elasticity of demand

• number and closeness of substitutes• time period

– the case of oil

• Responsiveness to changes in supply– price elasticity of demand

• number and closeness of substitutes• time period

– the case of oil

Demand curves with different price elasticity of demandDemand curves with different price elasticity of demand

P

Q O

P0

Q0

S0

S1

D2

D1

Q1 Q2

P1

P2

Cease-fire inIran-Iraq war

Yom Kippur War: Arab oil embargo

First oil fromNorth Sea

Revolutionin Iran

Iraq invadesIran

Recessionin Far East

Iraq invadesKuwait

New OPECquotas

World-widerecovery

World-wideslowdown

Impendingwar

with Iraq

OPEC’s firstquotas

Continuing worries about supply and rapid growth in

demand from China and India

Oil pricesOil prices

0

10

20

30

40

50

60

70

72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

$ per barrel

Actual price

Cost in 1973 prices

Efficiency of marketsEfficiency of markets

• Responsiveness to consumer wishes– price elasticity of supply

• Responsiveness to changes in supply– price elasticity of demand

• Responsiveness to consumer wishes– price elasticity of supply

• Responsiveness to changes in supply– price elasticity of demand

• Competition– survival of the fittest– new products– lower costs

• Minimum average cost in long run

– lower prices• Supernormal profits firms enter market price

• Competition– survival of the fittest– new products– lower costs

• Minimum average cost in long run

– lower prices• Supernormal profits firms enter market price

O

£

Q

LRAC

Effect of competition on price and average costEffect of competition on price and average cost

P1 = AR1

P2 = AR2

Q1 Q2QL

Min. AC

Efficiency of marketsEfficiency of markets

• Responsiveness to consumer wishes– price elasticity of supply

• Responsiveness to changes in supply– price elasticity of demand

• Competition– survival of the fittest– new products– lower costs and prices

• Responsiveness to consumer wishes– price elasticity of supply

• Responsiveness to changes in supply– price elasticity of demand

• Competition– survival of the fittest– new products– lower costs and prices

• Efficiency– productive– allocative

• Efficiency– productive– allocative

Allocative efficiency(under perfect competition with no externalities)

Allocative efficiency(under perfect competition with no externalities)

MSB = P = MSC

MSB > P buy moreMSB < P buy less

Until MSB = P

MSC < P produce moreMSC > P produce less

Until MSC = P

Thus in equilibrium MSB = MSC

Market failuresMarket failures

• Externalities

– External costs of production

– External benefits of production

– External costs of consumption

– External benefit of consumption

• Externalities

– External costs of production

– External benefits of production

– External costs of consumption

– External benefit of consumption

O

MC = S

DP

MSC

Co

sts

and

be

nef

its

Quantity

External cost

Q1Q2

Social optimum

External costs in productionExternal costs in production

Market failuresMarket failures

• Market power– Monopolies and oligopolies

– Aim to make demand less elastic• Restricting competition

• Product differentiation

– The case of supermarkets

• Market power– Monopolies and oligopolies

– Aim to make demand less elastic• Restricting competition

• Product differentiation

– The case of supermarkets

Waitrose3.8%

Other17.4%

Somerfield4.3%

Morrisons11.3%

Sainsbury's15.9%

Asda(Wal-mart)

16.7%

Tesco30.6%Waitrose

3.8%

Other17.4%

Somerfield4.3%

Morrisons11.3%

Sainsbury's15.9%

Asda(Wal-mart)

16.7%

Tesco30.6%

UK supermarket food market share (2006)UK supermarket food market share (2006)

Market failuresMarket failures

Market power:the case of supermarkets– Barriers to entry

• Buying up plots of land• Exclusive deals with suppliers

– Relationships with suppliers• Makes it harder for convenience stores

to compete

– Lack of effective price competition• Higher prices in areas where there is

less competition• Predatory prices where there is

Market power:the case of supermarkets– Barriers to entry

• Buying up plots of land• Exclusive deals with suppliers

– Relationships with suppliers• Makes it harder for convenience stores

to compete

– Lack of effective price competition• Higher prices in areas where there is

less competition• Predatory prices where there is

– Attempts to drive out competition• Entry to convenience store market

– Attempts to drive out competition• Entry to convenience store market

£

Q O

MC ( = supply under perfect competition)

Q1

MR

P1

P2

Q2

AR = D

Comparison withPerfect competition

Equilibrium of industry under perfect competition and monopoly: with the same MC curve

Equilibrium of industry under perfect competition and monopoly: with the same MC curve