Market Equilibrium

Question 1

What is the price mechanism?

Answer 1

The process where the forces of supply and demand interact to determine the market price at which goods and services are sold and the quantity produced

Question 2

What is market equilibrium?

Answer 2

The situation where at a certain price level the quantity supplied and the quantity demanded of a particular commodity are equal. This means that the market clears and there is no tendency for change in either price or quantity

Question 3

How is market equilibrium achieved and when does it occur?

Answer 3

• It is achieved in an individual market when any consumer who is willing to pay the market price for a good or service is satisfied and any producer who offers their goods or services at the market price is able to sell the product
• It occurs when quantity demanded is equal to quantity supplied, that is, when the market clears

Question 4

When does market equilibrium occur? (x3) (3 conditions)

Answer 4

• Quantity demanded = quantity supplied
• The market clears
• There is no tendency to change

Question 5

What is the product market?

Answer 5

The interaction of demand for and supply of the outputs of production i.e. goods and services

Question 6

What will producers do when there is an increase in demand for a product

Answer 6

Increasing demand for a product will be translated into a higher market price which will be a signal for producers to reallocate resources away from other areas of production in order to produce a demanded product

Question 7

What is allocative efficiency?

Answer 7

The economy’s ability to allocate resources to satisfy consumer wants

Question 8

What do the supply and demand curves indicate from producers and consumers?

Answer 8

The supply curve gives an indication of the producer’s costs in supplying the product and the demand curve gives an indication of the value that consumers place on a certain product.

Question 9

What does the market mechanism do? (x2)

Answer 9

• The market mechanism ensures that equilibrium is reached at the intersection of the two curves
• The market mechanism also ensures allocative efficiency in the economy

Question 10

How does competition influence producers?

Answer 10

It ensures that they are responsive to consumer demand and that they attempt to minimise their costs of production in order to remain competitive in the market and maintain their profitability. This means that the most cost efficient methods of production are used.

Question 11

When does market failure occur?

Answer 11

It occurs when the price mechanism takes into account private benefits and costs of production to consumers and producers but it fails to take into account indirect costs such as damage to the environment

Question 12

Define and describe the impact of Government price interventions (Price ceilings & price floors)

Answer 12

Price ceiling - the maximum price that can be charged for a particular commodity

Price floor - the minimum price that can be charged for a particular commodity

Price floors and price ceilings affect the distribution of income as price ceilings redistribute money from sellers to buyers and price floors redistribute money from buyers to sellers

Question 13

How and when the government use quantity intervention?

Answer 13

• The government use quantity intervention when negative externalities occur when producing the product
• The government then artificially restrict negative externalities by imposing taxes on businesses, which increase their production costs and reduce production levels. Making the individual business pay for the social costs created by the problem is known as internalising the externality

Question 14

Name the problems in the market, government action and outcome (x5)

Answer 14

Market price is too high - a price ceiling is used which reduces the price and leads to a quantity shortage [disequilibrium]

Market price is too low - a price floor is USD which increases the price and leads to a quantity excess [disequilibrium]

Market quantity is too high [n texts.] - Taxes are imposed which increases equilibrium price and reduces equilibrium quantity

Market quantity is too low [p exts.] - Subsidies are imposed which reduce equilibrium price and increase equilibrium quantity

Market does not provide goods or services - The government provides the good or service, collecting taxation revenue to finance its supply of public goods

Question 15

Name and describe all market structures

Answer 15

Pure competition - A theoretical model of perfect competition

Monopolistic competition - Many small firms in the industry

Oilgopoly - A small number of large firms dominate the industry

Monopoly - Only one producer in the industry

Question 16

Describe the market conditions which firms operating under pure competition are faced with (x5)

Answer 16

• There are many small buyers and none of them are large enough to affect the market price
• The products sold by all firms are homogenous
• Buyers do not incur any cost for moving one supplier to another
• There are no barriers to new firms entering or existing firms leaving the market
• Sellers can sell as much of their product as they like, at the market price

Question 17

What happens with firms under pure competition conditions? (x2)

Answer 17

• Firms are price takers - they must simply accept the market price determined by the forces of supply and demand. They can sell as much as they want at that price but no-one will buy their product if they sell above it.
• Firms would not sell below the market price as it would not be profit maximising

Question 18

Describe the characteristics of a monopoly (x3)

Answer 18

• There is only one firm selling the product and no market competition
• The product sold has no close substitutes
• There are significant barriers to entry and this effectively prevents any potential competitors from entering the market

Question 19

What happens with the monopoly under monopoly conditions? (x3)

Answer 19

• The monopolist has great control over the market price
• The monopolist is a price setter and can set the price of the product in order to maximise profit
• If a product were to be produced by a monopolist rather than under pure competition, the monopolist would restrict the output and raise the price

Question 20

What happens to price with different levels of competition?

Answer 20

As the level of competition within a market increases, prices are likely to fall and output is likely to rise

Question 21

Describe the characteristics of a monopolistic competition (x4)

Answer 21

• There are a large number of relatively small firms
• The products sold in the market are similar but not identical. The firms engage in product differentiation
• The fact that products are differentiated gives firms some degree of price setting power
• There are some small barriers to entry for new firms entering the market, including that existing firms have loyal customers who through product differentiation consider that their firm supplies the best products (brand loyalty)

Question 22

What is product differentiation?

Answer 22

• When firms try to make their good service look different from competitors through packaging or product image to increase brand loyalty and give the firm some price setting power

Question 23

Describe the characteristics of an oilgopoly

Answer 23

• There are only a few relatively large firms, each of which has a significant share of the market
• They sell similar but differentiated products
• There are significant barriers to entry, and this accounts for that there are only a few firms in the industry