Markets+and+the+Market+Process

> Since resources are scarce, we have to make decisions about how we will allocate the available resources; that is, decide which goods and services will be produced, and who will get what is produced. While there are many different methods that people can use, the market mechanism is one that is frequently used, primarily because it is usually (but not always) the allocation method with the highest **efficiency**. > >  > A market is a mechanism for bringing together buyers and sellers so that they can exchange goods and services. The market process refers to the way buyers and sellers interact in making decisions that allocate our scarce resources. > >  > **Demand** is the quantity of a good or service that buyers are willing and able to buy at various prices. People often confuse demand with **quantity demanded**. Demand refers to a list of quantities and prices. Quantity demanded is the amount of a good or service that people are willing and able to buy at //one// specific price. It's correct to say, "If the price of a hair dryer is $15, the //quantity demanded// is 20." It is NOT correct to say, "The demand for hair dryers is 20." > > The **law of demand** states that as the price of a good decreases, people will buy more (and vice versa). That's why stores have sales to get rid of merchandise they can't sell; they know that if they lower the price, people will buy more. > > When economists construct a **demand schedule**, they hold everything except the price constant and determine the quantities consumers will buy at all the possible prices. However, things other than price affect how much of a good or service people are willing to buy. These other **determinants of demand** are income, tastes, prices of related goods and services, consumers' expectations, and the number of buyers. The exchange rate is also a determinant of demand. When one of these determinants of demand changes, the whole demand schedule changes. > > Economists take seriously the adage, "A picture is worth a thousand words," so they draw pictures of demand schedules. These pictures are called **demand curves**. Price is put on the vertical axis and quantity on the horizontal axis. Demand curves slope down from left to right. When one of the determinants of demand changes, the demand curve shifts to the left or to the right. > >  > **Supply** is the quantity of a good or service that sellers are willing and able to offer for sale at various prices. People often confuse supply with //quantity supplied//. Supply refers to a list of quantities and prices. Quantity supplied is the amount of a good or service that people are willing and able to offer for sale at //one// specific price. It's correct to say, "If the price of a hair dryer is $15, the quantity supplied is 10." It is NOT correct to say, "The supply for hair dryers is 10." > > The **law of supply** states that as the price of a good increases, people will offer more for sale (and vice versa). That's why people offer a seller a higher price for the product when there is a shortage; they know that the higher price will entice the producer to produce more. > > When economists construct a **supply schedule**, they hold everything except the price constant and determine the quantities producers will offer for sale at all the possible prices. However, things other than price affect how much of a good or service people are willing to supply. These other determinants of supply are prices of resources, technology and productivity, expectations of producers, the number of producers, and the prices of related goods or services. When one of these **determinants of supply** changes, the whole supply schedule changes. > > A picture of a supply schedule is called a **supply curv**e. Again price is put on the vertical axis and quantity on the horizontal axis. Supply curves slope up from left to right. When one of the determinants of supply changes, the supply curve shifts to the left or to the right. > >  > The price of a good or service changes until the equilibrium price is reached. **Equilibrium** is the point at which the quantity demanded equals the quantity supplied at a particular price. At prices above the equilibrium price, the quantity supplied is greater than the quantity demanded, so a **surplus** develops. Sellers must lower their prices to get rid of the goods and services that accumulate. At prices below the equilibrium price, the quantity demanded is greater than the quantity supplied, and a **shortage** develops. Sellers see the goods and services quickly disappear and realize they could have asked for a higher price. The price goes up until the shortage disappears. > >  > Price may change when demand or supply change. When demand or supply change, they will create either a surplus, leading to a lower price, or a shortage, leading to a higher price. > >  > While the market is usually an efficient system for making allocation decisions, under some conditions it doesn't work efficiently, or it doesn't make decisions the way people want the decisions made. For example, most people don't like the idea of deciding who gets a heart transplant by seeing which potential recipient is willing to pay the most—that doesn't seem like a fair method to most people. > > Several circumstances can cause problems in relying on markets to make the most efficient decisions. When there are **transactions costs** involved in buying a good or service in the market, firms may decide to provide the good or service themselves, rather than buying it from someone else. For example, if a business needs repairs on some of their equipment, a manager could search the phone book for another firm that fixes that type of equipment, negotiate a contract with that firm, and then make sure the work got done properly. Many times, it's much less expensive and more efficient to just hire a mechanic as a permanent employee. > > **Market failure** can also make markets to work poorly. When no one owns a resource (like fish in the ocean), markets don't allocate resources efficiently (fish get caught faster than they can reproduce, leading to decreased catches in the future). Also, when there are **positive externalities** or **negative externalities**, markets don't take into account all the benefits or cost of producing and consuming a product.
 * Fundamental Questions **
 * 1)   **How are goods and services allocated?**
 * 1)   **How does a market work?**
 * 1)   **What is demand?**
 * 1)   **What is supply?**
 * 1)   **How is price determined by demand and supply?**
 * 1)   **What causes price to change?**
 * 1)   **Why isn't the market used to allocate everything?**