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Allocation of resources: markets and market failure

Individual and market demand; the law of demand; conditions of demand (income, prices of substitutes and complements, tastes, advertising, population). Supply and its conditions (costs, technology, weather, taxes and subsidies). Movements along curves versus shifts.

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Demand and supply

Individual and market demand; the law of demand; conditions of demand (income, prices of substitutes and complements, tastes, advertising, population). Supply and its conditions (costs, technology, weather, taxes and subsidies). Movements along curves versus shifts.

Price determination

Equilibrium where demand equals supply; excess demand and supply; effects of changes in conditions.

Elasticity

  • Price elasticity of demand (PED) = %Δ quantity demanded ÷ %Δ price; elastic, inelastic, unitary; effect on total revenue; determinants.
  • Price elasticity of supply (PES) and its determinants.

Worked example: Price rises from US$2 to US$2.50 and quantity demanded falls from 400 to 300. Find PED.

%ΔQ = −25%; %ΔP = +25% → PED = −1 (unitary)

Market economic system

Advantages (efficiency, choice, innovation) and disadvantages (inequality, market failure).

Market failure

Public goods, merit and demerit goods, external costs and benefits (social cost = private + external cost), abuse of monopoly power, factor immobility.

Mixed economy and government intervention

Maximum and minimum prices, indirect taxes, subsidies, regulation, privatisation and nationalisation, direct provision.

Exam tip: Use correctly labelled diagrams for every demand and supply change.

Check yourself

  1. What happens to equilibrium price when supply decreases?
  2. Why are public goods underprovided by markets?
  3. Give an example of a negative externality.
Show answers
  1. It rises (and quantity falls).
  2. They are non-excludable, so people can benefit without paying (free-rider problem).
  3. Pollution from a factory affecting nearby residents.
Next topicMicroeconomic decision-makers

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