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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