How a competitive market functions

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Competitive markets

  • The purpose of a market is to set an optimum price that is acceptable to both buyers and sellers. In some, the price is set and consumers will look for cheaper alternatives if the price is unnacceptable. In other markets, there may be bartering until a good price is reached. 
  • Equilibrium suggests a condition of stability. In disequilibrium, there is likely to be a further change or reaction by buyers or sellers. 
  • Price mechanism - the means by which economic decisions taken by consumers and producers interact to determine the allocation of scarce resources between competing uses. 
  • Excess supply - (glut) signal and incentive mechanisms
  • Excess demand - Signal, incentive and ration mechanisms
  • ceterus paribus - all other things being equal
  • joint supply - an increase in the supply of good A, increases supply og good B.
  • Factor markets - an initial change in demand for one good will lead to a change in demand for its factors of production.
  • Complementary goods - when demand for good A rises, so does demand for good B
  • Substitutes - If price of good A rises, then the demand for its substitutes will rise.
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Price ceilings and price floors

  • Maximum price is always shown as a dotted line UNDER the equilibrium line as if it is above, it will have no effect. This results in excess demand. Normally, prices would rise to eliminate this and encourage an extension in supply. However, this cannot happen here so the excess demand remains, usually in the form of a queue or waiting list. 
  • Maximum price can lead to 'black markets' emerging where additional illegal supply is sold to those who are willing to pay more. 
  • Minimum price is always shown as a dotted line ABOVE the equilibrium line as if it is below, it will have no effect on the equilibrium price. This results in excess supply, which, in a free market, would be solved falling prices causing extensions in demand and contractions in supply until a new equilibrium is reached. e.g. minimum wage.  
  • zero pricing - when goods are provided free at the point of use (market price of zero) e.g. NHS: pay for it through taxes, but free at point of use. If there is excess demand, there will be a waiting list.  
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