1. Markets in Action
Gregory Chase
ACK

2. Changes in market equilibrium
• Supply and demand analysis explains many of
the events that occur in the real world.
• Changes in prices and quantities sold in
markets primarily occur because of:
– changes in demand
– changes in supply
2

3. Changes in demand
From Last Week
Changes in demand occur as a result of changes in:
number of buyers in the market
tastes and preferences
levels of disposable income
expectations of consumers
prices of related goods
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4. 4
Changes to demand
If one of these factors
causes a decrease in
demand, the result will be:
a decrease in
prices
a decrease in
quantity
supplied.
If one of these factors causes
an increase in demand, the
result will be:
an increase
in prices
an increase
in quantity
supplied.

5. Change in Demand
• Consider the demand for New Zealand (NZ)
holidays
• Movie Lord of the Rings was filmed in NZ
• This caused a change in consumer tastes and
preferences – increasing demand for NZ
holidays
• As demand increases we expect price to
rise, as well as the quantity of holidays traded

6. An increase in demand
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7. • High Fuel Consumption Autos
• Causes
Recent events: appreciation of Australian Dollar
Past events: failure of local manufacturers to
respond to changes in consumer demand for smaller
cars as petrol prices increased (complementary
product)
Improved safety features in small cars
• Result: decrease in demand for cars with large
engines in preference for fuel efficient cars
A decrease in Demand

8. A decrease in demand
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9. 9
Review: Market supply
•Assumed market supply is directly related to price.
•Based on assumption of “increasing costs”
•As production increases, the cost of each additional unit of output
increases (increasing marginal cost)
•If a firm faces increasing marginal cost, then they would only be willing to
increase supply if they receive a higher price
•The result is an upward sloping supply curve
•But is this always the case?

10. Constant Cost, supply and price
• In reality, firms can often respond to increased demand without
increasing price
• Wood-oven pizza restaurant factors of production:
• Pizza oven, one pizza maker, wood, pizza ingredients etc.
• Production = 20 pizzas per hour
• What is the additional cost of producing the 10th, 11th or 12th pizza?
• In this situation, the producer does not experience increasing marginal
cost
• Price does not need to increase as demand increases from 10 to 11 or
from 11 to 12 pizzas.
• As production increases, the cost of each additional unit of output
remains the same (constant marginal cost)
• Flat (elastic) supply curve in this range of production

11. Constant Cost and Supply
SC
What if we had
considerable
excess capacity
in both airline
seats and hotel
rooms?
Constant costs
could mean no
increase in
price until
seats and
rooms started
to become
scarce

12. Changes in supply
From Last Week
Changes in supply occur as a result of changes in:
technology
number of sellers in the market
resource prices
taxes and subsidies
expectations of producers.
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13. 13
Changes in supply
If one of these factors
causes an increase in
supply, the result will be:
a decrease in
prices
an increase
in quantity
demanded.
If one of these factors
causes a decrease in
supply, the result will be:
an increase
in prices
a decrease in
quantity
demanded.

14. Change in Supply
• Each choice has an opportunity cost: consider the
following scenario
• An entrepreneur presently has $1 million invested in a
machinery hire business: 6% return on investment (ROI)
• Suit hire business: ROI = 12%
• Profit maximising entrepreneur decides to shift their
investment into the suit hire business
• Supply will increase in the suit hire sector (and decrease in
machinery hire)

15. An increase in supply
15
40
30
20
10

16. Analysis
• Market entry causes surplus at original price
• Price falls and quantity traded increases until
equilibrium is restored
• As price falls, the ROI (profit) will fall
• As the ROI falls, so too does opportunity cost
• Resources stop shifting into this market
• If resources were free to move between
markets – the ROI (profit) would be equalised in
all industries
• In reality, barriers to entry and exit

17. A Decrease in Supply
• Timber is a natural resource
• It is a renewable resource – plantation timber
• But also finite – old growth forests such as the Amazon
• Scientific evidence: logging of old growth forests is
creating considerable environmental cost, often beyond
the countries in which logging is taking place (Amazon
rainforest produces 20% of earths oxygen supply)
• Government regulation introduced to restrict logging

18. A decrease in supply
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19. Analysis
• A reduction in supply causes a shortage at the
original price
• This excess demand causes price to increase
and quantity traded to fall
• This continues until the price consumers are
willing to pay equals the price at which
producers are willing to sell
• Price acts to “ration” scarce goods and services
towards those that value them most highly
(marginal value) and have the ability to pay

20. Crude oil supply
 Organisation of Petroleum Exporting Countries
 12 countries with about 80% of world oil reserves
 Rather than competing, these countries coordinate supply to increase
revenue (export earnings) and profits
 With few substitutes, demand is not very responsive to changes in
price (demand is price inelastic)
 By reducing supply, price will rise and quantity traded will fall
 However, total revenue will increase since demand is price inelastic
OPEC
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21. Profit maximising
Price
of Oil
1.2m
$60
S1
Quantity of Oil
S2
D
$130
1m
•TR = P x Q
•TR1 = $60 x 1.2m = $72 million (Area A + B)
•TR2 = $130 x 1m = $130 million(Area B + C)
•Area A = loss of TR
•Area C = gain in TR
•Area C > A so TR increases
AB
C
E1
E2

22. Government intervention
• Governments intervene in the operations of the
market system for several reasons, including:
Efficiency
Equity
• We now consider some examples:
Price Floor and Price Ceiling
Market Failure
Externalities
Public Goods

23. 23
Price ceilings
• A price ceiling is a legally established
maximum price a seller can charge.
• Governments impose these to ensure that
the wider community can access the
product/service sold.
• It can cause an excess of quantity
demanded over quantity supplied at the
ceiling price.

24. The Market for Social Housing
• Social housing: government provided housing to
low-income individuals or families
• Market rents can be unaffordable for some
individuals and families
• In a free market – this would cause homelessness
• Improve affordability by setting a price below the
market rent
• Justification for government provision is equity

25. Price ceilings
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26. 26
Price ceilings (cont.)
• Rent ceilings help people on low incomes
by keeping prices lower than the
equilibrium.
• They can be counterproductive if they
cause:
– excessive shortages
– illegal markets
– less maintenance
– discrimination

27. Price floors
• A price floor is a legally established minimum
price a seller can be paid.
• Governments can create these in order to
lower the consumption of a good, or ensure
some employees are not disadvantaged.
• It can result in an excess of quantity supplied
over quantity demanded at the floor price.
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28. Minimum Wage
• The market for labour
• Individuals supply labour - Firms demand labour
• Wage rate determined by the interaction of
demand and supply
• What if the wage rate is so low that you can’t
afford the essentials of life?
• Australia has a minimum wage to improve
equity
• Minimum wages USA

29. Price
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30. 30
Examples of price floors
• Price floor examples are minimum wages and
agricultural price support schemes.
• These can also have unintended consequences:
– unemployment
– overproduction and waste of resources.
Trade-off: The pursuit of equity can create
inefficiency
Policy Making is often requires balancing the
twin goals of equity and efficiency

31. 31
Market failure
• The price system may not always operate
efficiently, as society fails to achieve some goals.
• The market mechanism does not achieve
desirable results.
Four
examples
• Lack of competition
• Third party effects (externalities)
• Public goods
• Income inequality

32. Market failure: lack of competition
• Consumer sovereignty is replaced by
‘producer sovereignty’.
• Firms without competitors tend to restrict
supply, which raises prices and profits, and
reduces community well-being by wasting
resources and retarding innovation.
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33. Cartel
Price
of Oil
1.2m
$60
S1
Quantity of Oil
S2
Demand
$130
1m
•Competitive price is $60 and 1.2 million
barrels produced per day
•Cartel restricts supply and pushes price
to $130 per barrel
•This results in a transfer of income from
consumers to producers
•Area C was consumer surplus and is
now producer surplus
• Deadweight loss = area A + D
AB
C
D

34. Review: price elasticity & TR
34
TR1 = P*Q = $30x10,000 = $30,000
If price is lowered to $20
TR2 = $20x30,000 = $60,000
Loss of TR
Gain in TR

35. Variations along a straight-line
demand curve
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Notice how TR reflects the variation in elasticity along
the demand curve.

36. Public goods
• users collectively consume
benefits
• no-one can be excluded
Goods that
have two
properties:
Public goods are goods that are
consumed by everyone regardless of
whether they pay or not.
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37. Categories of goods
Excludable Non-excludable
Rivalry Private Goods
(Cars, cloths, food)
Common Goods
(fish, timber, rivers)
Non-Rivalry Club Goods
(satellite TV)
Public Goods
(Air, national defence,
free to air TV)
Criteria
•Rivalry: consumption by one person precludes
consumption by another person (resource depletion)
•Exclusion: it is possible to exclude a person from
consumption of the good (user pays)

38. Public goods
• The characteristics of a public good –
particularly non-excludability - means that
firms will not produce them
• Consider National Defense – who benefits?
• If you can benefit (consume) without
paying, why would you pay for it?
• Free riding – leads to under-production or no
production
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39. Market Failure: Externalities
• Market transaction: buyers and sellers come together
voluntarily for the purpose of exchange
• Mutual gains from trade
• An externality is a cost or benefit imposed on third parties
(people other than the buyers and sellers of the good).
• Spill-over effect
• Externalities can be:
– positive (beneficial spill overs)
– negative (harmful spill overs).
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40. 40
Negative externalities
• Those that are detrimental to third parties:
– a neighbour’s consumption of loud music may
reduce your ability to study
– noise pollution caused by aircraft
– smoke from a factory.
• Approaches to solving these ‘failures’ are:
– taxes (e.g. pollution taxes)
– regulations (to limit pollution).

41. Case Study: Carbon Tax
• Air (the atmosphere) is a public good
• Carbon and other pollutants released into the
atmosphere
• External costs imposed locally (ill-health from air
pollution) and internationally (global warming)
• External costs not reflected in the market price
and quantity traded
• How do we internalise these external costs?
• How does carbon pricing work? Part 1 and Part 2

42. Negative externalities
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Economists prefer a tax-based solution because it is more
efficient.

43. Positive externalities
• Externalities that are beneficial to third
parties, for example:
– government expenditure in schooling benefits
the whole of society, not just students
– vaccinations provide a direct benefit to the
patient and a spill-over benefit to other people
(less chance of contracting the disease).
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44. Positive externalities
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45. Society encourages positive spillovers
• There are government subsidies for attending
school and being vaccinated against disease.
• Regulations push the demand curve for
positive spillover type commodities to the
right, for example:
– laws about immunisation of infants
– laws about attending school.
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46. Income inequality
46
•Economics: what, How and for Whom
•For whom is about income distribution
•Income depends on education, skills and experience
•How much income would your earn in a pure market
economy if you were unemployed?
•Income inequality is a major part of the incentive
structure inherent in a market system
•This market imperfection is addressed via
• government regulation (subsidised training)
•Tax-transfer system (unemployment benefits)