Chapter 3

Market System
Elements of Economics

Slides prepared by Leigh Lim

Concept of Scarcity
 Scarcity: resources are limited as well has
have may competing uses. The more
complicated human wants become, the
more resources are needed to fulfill them.
The problem of scarcity becomes intense.
 Shortage: a situation wherein the supply of
a particular commodity is deficient to meet
its demand at a prevailing price.
The Price as an Index for Scarcity
 The Market System uses the forces of demand
and supply to determine the price of a
commodity
 If the price of a commodity is increasing, it
indicates that the commodity is becoming
relatively scarce. As a consequence, consumers
will limit their consumption of that commodity.
Producers, on the other hand, will have an
incentive to increase production because of the
lure of higher profits.
 So what happens when the price is decreasing?
Market System: Answering the
problems of production &
distribution
 The price system can also be the basis for
making production decisions and distribution of
goods in the economy.
 Production: If the price of labor is relatively
cheaper than the price of capita, then more labor
will be used.
 Distribution: The high purchasing power of
individuals derived from receiving higher income
is a reflection of high productivity of the
resources they own as well as the high returns
they receive as factor inputs.
Setting the Market Price:
interaction of demand and supply
 Price is an index worth of products,
services and wealth
 Market is described as a state when and
where transactions are made between
sellers and buyers, the price of a
commodity will depend on the interaction
between buyers and sellers
Setting the Market Price:
interaction of demand and supply
 Buyers: wants and preferences are the factors
that shape their demand for various goods and
services. A good is purchased based on the
value they attach to the good, and this value or
consumer satisfaction is reflected in the price of
the good
 Producers: willingness to supply a good will
depend on their cost of production. Usually
producers compare their cost with the price.
Setting the Market Price:
interaction of demand and supply
 At a high price, consumers tend to
consume less because they feel that they
have to economize, while producers are
willing to supply more because there are
more firms that are efficient in production
at a higher price. = results in surplus
 The opposite happens when the price is
low. = shortage
Setting the Market Price:
interaction of demand and supply
 Market Equilibrium
point (E) there is no
pressure to change
the situation since
both buyers and
sellers agree in the
price and amount of
the product traded
 Shortages and
Surpluses are
disequilibrium
conditions
The Demand Schedule and the
Demand Curve
 This shows the willingness and ability of a
buyer to purchase a product in alternative
prices at a particular period of time, ceteris
paribus (the other factors influencing the
demand of the product are not changing)
The Demand Schedule and the
Demand Curve
Demand for Fish Balls Dem and Schedule of Fish Balls

3.00
Alternative
Combina 2.50 A
tion Unit Price Quantity B
2.00 C

Price, P
A 2.50 5 G
1.50 H
B 2.25 10
1.00 I
C 2.00 15
0.50
G 1.75 20
0.00
H 1.50 25 5 10 15 20 25 30
I 1.00 30 Quantity, Q

Connecting all the points in the graph, we form demand curve, D

The Demand Schedule and the
Demand Curve
 Law of Demand: There is a negative relationship
between price and quantity demand. If the price
is high, the demand is small.
 2 reasons why the demand for a product
increases as price decreases
 Substitution Effect: if the price of the commodity
decreases, there is a substitution from the expensive
product to a cheaper one
 Income Effect: If the price of a commodity increases
despite no change in income, the ability of the buyer
to purchase a commodity will decrease
The Supply Schedule and the
Supply Curve
 This shows the ability of the producers to
sell a product or service at alternative
prices at a particular period in time, ceteris
paribus (other factors affecting supply are
not changing)
The Supply Schedule and the
Supply Curve
Supply of Corn on Cobs Supply Schedule of Corn on Cobs
Alternative
Combin
ation Unit Price Quantity 30

25 W
R 5 50
20 Y

Price, P
T 10 100
15 U
U 15 150 10 T

Y 20 225 5 R

0
W 25 275
50 100 150 225 275
Quantity, Q

Connecting all the points in the graph, we form supply curve, S

The Supply Schedule and the
Supply Curve
 Law of Supply: At a low price there is little
amount being supplied because there are
very few efficient producers that can
match this low price with their cost of
production. But as the price continues to
increase, producers with high cost of
production become more efficient as their
higher cost of production can now match
the higher price in the market.
Changes in Demand
 Besides the price of the commodity, the
income of consumers, expectation, tastes,
and preferences can also affect the
demand for a product.
 The negative relationship between price
and quantity demand will still hold.
 What happens is that the demand curve
shifts when other factors affecting demand
are changing.
 Changes in Demand
Changes in Demand for Chicken due to
Income Increase
Demand at Demand at
Shift in Demand Due to Income Increase
Price per lower higher
Kilo income income
300
250 5 20

Price per Kilo, P

250 A A'
220 10 25 B B'
200
K K'
180 15 30 150 H H'
140 20 35
100 G G'
50 I I'
100 25 40
0
60 30 45
0 10 20 30 40 50
Kilos of Chicken, Q

The increase in demand resulting from an increase in income shifts the demand
curve to the right
Changes in Supply
 Besides the price of the commodity, the prices of
inputs, both factors and raw materials, changes
in productivity and external factors can change
the supply of goods and services.
 The positive relationship between price and
quantity supplied will still hold.
 What happens is that the supply curve shifts
when other factors affecting supply are
changing.
 Changes in Supply
Change in supply of Hopia Due to Increase in
Input Prices Shift in the Supply Curve due to Increase in
Supply Before Supply After
Input Prices
the the
Price per Change change
Doz in Input in Input
40

Price per Dozen, P

en Prices Prices
K' K
10 30 20 30 J' J
H' H
15 60 25 20 F' F
B' B
20 90 30 10 A' A
25 120 35 0
30 150 40 0 50 100 150 200
Dozens of Hopia, Q
35 180 45

The decrease in supply resulting from an increase in input prices shifts the
supply curve to the left
Applications in the Analysis of
Supply and Demand
 Setting the Minimum Wage
 In the labor market, workers are the ones
supplying labor services. Laborers are
willing to render more hours of work if the
price of labor (wage rate) is increased.
Firms are the ones consuming labor
services and they are willing to increase
demand if the wage rate is decreased.
Applications in the Analysis of
Supply and Demand
(Minimum Wage)
 If the government
sets a minimum wage
above the equilibrium
wage rate determined
by the market, a
disequilibrium occurs.
 As a result, there will
be huge
unemployment
Applications in the Analysis of
Supply and Demand
 Exchange Rate Control
 The commodity sold is dollar and its price
is shown in terms of peso per dollar or
currency exchange rate
 If the price of dollar is high, importers
would demand less of the foreign
currency, while exporters will have the
incentive to increase exports.
Applications in the Analysis of
Supply and Demand
(Exchange Rate Control)
 Setting up a foreign
exchange control
which sets the price
of dollar below its
equilibrium exchange
rate of 70php per US
dollar (50 php) will
lead to an excess
demand of dollars
amounting to QmQy
Demand and Supply in the Black
Market
 When the government intervenes in the
market, it can lead to a disequilibrium
situation which ultimately can end up with
the formation of a black market for the
regulated good
 Using the previous example, if the
government limits the supply of dollars, the
black market might occur, in this case the
supply curve of dollars will shift.
Demand and Supply in the Black
Market
 At a price lower than 50, there
is no risk, but at price higher
than 60, the supply curve will
increase steeply (due to
danger and risk of illegal
operation) compared to the
original supply curve. At the
new supply curve the
equilibrium price of dollar can
be 90
 Therefore, it is possible that
the price set in the black
market for dollars be higher
than the equilibrium price if the
market was not controlled
Applications in the Analysis of
Supply and Demand
 Effect of Taxes on
Market Equilibrium
 Tax: A charge placed
on the production of a
good and service by
the government. A tax
will increase the cost
of production to the
producer. It is makes
it more expensive to
produce
Effect of Taxes and Subsidies on
Market Equilibrium
 Effect of Subsidies on
Market Equilibrium
 Subsidy: This is a payment
of money by the
government to a producer
in order to encourage them
to produce or supply a
certain good or service. A
subsidy will reduce the cost
of production to the
producer. It makes it
cheaper to produce.
Conclusion
 We have seen how the market system operates
in determining the value of various commodities.
Aside from showing how the equilibrium price
was established using demand and supply
analysis, we have seen several applications of
this simple framework in understanding the
consequences of disequilibrium situations
arising from setting the price beyond or below
the market determined level.