Chapter 8: Market equilibrium and and gov intervention

Question 1

define market equilibrium

Answer 1

the quantity supplied and the quantity demanded of a particular commodity are equal. Ie when the supply and demand curve intersects

This means that the market clears (there is no excess supply or demand ie no shortage or surplus
the equilibrium price is also known as the market-clearing price

Question 2

A basic analysis of market equilibrium is based on 2 important assumptions:

Answer 2

That we have competition in the marketplace - that is no firm has the power to influence market outcomes directly (eg setting prices)

That there is no gov intervention

Question 3

what is the price mechanism?

Answer 3

Price mechanism is the process by which the forces of supply and demand interact to determine the market price at which goods and services are sold and the quantity produced.

Question 4

Explain how the market will reach market equilibrium if there is excess demand

Answer 4

Suppliers will start to supply more as demand drives the price up ie expansion in supply in order to meet the demands of consumers –> resulting in market equilibrium

Question 5

Explain how the market will reach market equilibrium if there is excess supply

Answer 5

Supplier will start to lower prices and quantity supplied as ppl are no longer buying it ie contraction in supply to expand demand by having cheaper prices –> resulting in market equilibrium

Question 6

Market equilibrium occurs when:

Answer 6

quantity demanded=quantity supplied
tha market clears
there is no tendency to change

Question 7

changes in equilibrium: what happens to price quantity and supply when demand increases/decreases

Answer 7

when demand increases (shifts to the right)
there is an increase in equilibrium price, increase in equilibrium quantity and thus expansion in supply

when demand decreases (shifts to the left) there is a fall in equilibrium price and fall in equilibrium quantity and thus a contraction in supply

Question 8

changes in equilibrium: what happens to price quantity and demand when supply increases/ decreases

Answer 8

when supply increases (shift to the right), there is a fall in equilibrium price, an increase in equilibrium quantity and thus an expansion in demand

when supply decreases (shift to the left), there is a rise in equilibrium price and a decrease in equilibrium quantity thus a contraction in demand

Question 9

Why does gov intervene in market?

Answer 9

if left to operate by itself, the market can creat unsatisfactory outcomes
Market prices for products or factors of production may be considered too high or too low, equilibrium quantities may be considered too high or too low, and some products may not be produced at all
Market failure occurs when markets produce less than optimal outcomes cos priv sectors focus on profit and not social benefit

Question 10

define market failure

Answer 10

Market failure occurs when the price mechanism takes into account priv benefits and costs of production to consumers and producer, but it fails tot ake into account indirect costs such as damage to the environment

Question 11

outline the market failure graph

Question 12

what is a price ceiling

Answer 12

the maximum price that can be charged for a particular commodity to protect consumers from buying a disadvantaged price (unfavourable market conditions)

Question 13

what is a price floor

Answer 13

the minimum price that can be charged for a particular commodity to protect producers from selling at a disadvantaged price (unfavourable market conditions)

Question 14

How do black markets form?

Answer 14

Price control schemes often lead to the formation of black markets as some consumers will be willing to pay market price (or higher) for the available quantity supplied

Question 15

define positive and negative externalities

Answer 15

positive - social benefits that come with individual consumption of some goods and services eg parks, public transport, police

negative - unintended public consequences of private actions eg air and water pollution from production. They arise bcos most environmental resources are not priced in the market and ppl don’t have to pay for the social cost

Making the individual business pay for the social costs created by production is known
as internalising the externality.

Question 16

define merit and demerit goods

Answer 16

merit goods are goods that gov believe are beneficial to society but are not produced in adequate quantities bcos market is too small and there is little incentive to produce despite positive externalities

demerit goods are supplied by businesses but have negative externalities eg alcohol and cigarettes

Question 17

imposition of indirect taxes - why do gov intervene in markets?

Answer 17

control consumption of harmful goods eg cigs
encourage responsible consumption of scare resources
raise revenue thru tax

Question 18

what are indirect taxes?

Answer 18

the tax from the person who is levied passes it on to consumers in the form of higher prices ie excise duties (tax on specific G&S such as fuel and alcohol)
How much depends on the price elasticity of demand

Question 19

What are the impacts of indirect tax on the market economy

Answer 19

Imposition of a sales tax leads to a decrease in supply, raising the equilibrium price and reducing the equilibrium quantity
the more inelastic demand the easier it is to pass on the tax
the more elastic demand is the harder it is to pass on the tax and the firms have to bear the rest

Question 20

what happens when the market doesnt provide a G or S

Answer 20

the gov provides the good or service eg transport

Question 21

what are public goods?

Answer 21

Public goods are goods and services that are both non-excludable and non-rival(just cos other ppl buy it doesnt mean u cant) in that individuals cannot be excluded from consumption, and consumption by one individual does not reduce availability to others eg law enforcement and defence

Question 22

Outline pure/perfect market

Answer 22

a large number of firms with the same product (homogeneous product) where they all don’t have the market power to raise prices above the competitive equilibrium or else they will lose all customers to competitors

no barrier to entry (ie to establish business in this market will be easy and not highly regulated) eg textiles - low regs

for AUS - the industry that best reflect perfect competition is commodity based industry: agricultural and minerals

Question 23

Outline monopolistic competition

Answer 23

A large number fo relatively small firmsand the products sold are similar but there is slight product differentiation (ie packaging)
this differentiation gives firms some degree of price setting power
small barriers to entry for new firms (existing firms have brand loyalty)
lots of competition and advertising is important in attracting new customers and maintaining existing ones
eg hairdressers

Question 24

Outline the features of an oligopoly

Answer 24

Form of imperfect competition witha few relatively large firms each with significant share of the market. They sell similar but differentiated products and there are significant barriers to entry as there are only a few firms in the industry and there are a lot of regulations for production and lvl of capital needed

predatory pricing - in response to new firms entering, firms would lower prices knowing new firms spent a lot on capital and lowering prices would decrease their potential revenue and ability to recover the money spent already. bad for consumers cos there’s less competition ie less variety ie higher prices

Firms have to monitor the behaviour of competitors eg if a firm lowered its prices then all the other firms would have a price cutting war that could deplete profits (price rigidity - avoiding price cutting war) . bcos of this they tend to compete thru ads
egs are supermarkets - wooleis and coles, airlines - qantas and virgin

firms are price makers cos of their high price setting power

Duopoly same but worse and b/w two firms only

Question 25

outline the features of a monopoly

Answer 25

A single large business with a unique and differentiated product and are the price setter or can set output (not both)
barrier to entry impossible due to capital outlay req’d thus most monopoly held by public sector (ie gov) eg sydney water, auspost
undesirable as consumers have no variety and prices are high

gov (ACCC, competition and consumer act 2010) intervene by encouraging new competitor to control the prices eg telstra

Question 26

outline market structures

Answer 26

the no# and size of forms, the nature of the product sold and the ease of entry of new firms into a particular industry or market
market strucs can be analysed in terms of:
structure, conduct(pricing and output) or performance