Topic 6 Dynamics Of Market 2022 PDF

MICROECONOMICS PAPER II TOPIC 1 Dynamics of markets The market as a phenomenon (demand and supply). Use graphs to illustrate the establishment of prices and quantities. 3 weeks to cover content Week...

MICROECONOMICS PAPER II TOPIC 1 Dynamics of markets The market as a phenomenon (demand and supply). Use graphs to illustrate the establishment of prices and quantities. 3 weeks to cover content Week Week Learners should cover the following: Description Types of markets: Prices: Functions of markets: Value, price and - perfect markets - demand utility - imperfect markets - supply - bringing supply - world markets (the - price formation and demand Composition effects of electronics) together - allocating resources - self-regulatory Learners must first give an description of the following words in their notebook: Vocabulary List 1 Describe the term “Market” A market is any place or any circumstance where buyers and sellers make contact or communicate with each other about the buying and selling of goods and services. OR A market is an institution or mechanism that brings the buyers and sellers of a good or a service together. OR A market is a place where buyer and sellers exchange goods and services. The activities that happen markets 1. Buyers and sellers exchange information. 2. Price and quantities are determined. 3. The amounts of goods and services that will be bought or sold are determined. Value, Price and Utility Value, price and utility Value Value is the maximum amount of money a person is willing and able to pay for goods or services. Value is expressed in Rand and cents. Value of goods or services equals Price multiplied by Quantity (Value = P x Q). Price Price is the amount that is actually paid for a goods and/or services. The price is determined by both the demand for and supply of the goods and service. Utility Utility is the degree of satisfaction that a household or consumer derives or expects to derive from the consumption of a good or service. Utility Description of the term: Utility Utility is the degree of satisfaction that a household or consumer derives or expects to derive from the consumption of a good or service. 2 Characteristics of utility Utility differs from person to person Tastes and preferences differ from person to person and this mean that people get different satisfaction from the same good. Person A likes burgers and derives more satisfaction from it. Person B who does not like burgers but like chicken derives less satisfaction from burgers but more satisfaction form chicken. Utility is subjective Utility cannot be measured in numerical terms. Utility differs from time to time A light gives more utility in the night than in the day because the utility for a light decreases during the day. Utility differs from place to place A consumer may derive a higher or lower utility for the same good at different places. The consumer may find more utility from a woolen jersey in cold areas but less utility for it near the equator. Utility does not necessarily mean usefulness. E.g. cigarettes have utility to the smoker because it satisfies a want but it lacks usefulness because it is injurious to the health. Measuring Utility Total Utility Total utility is the utility derived from all the units that were consumed in succession. Number of slices of bread Total utility Marginal utility 1 16 16 2 28 12 3 36 8 4 40 4 5 40 0 6 36 -4 John is consuming bread and he eats 7 slices of bread consecutively. When he eats his 1 slice he derives 16 units of utility, 2 slices he derives 28 units of utility, 3 slices = 36 units of utility, 4 slices = 40, 5 slices = 40 and 6 slices = 36 units of utility. 3 Marginal utility Marginal utility is the utility derived from the additional (extra) unit of a given good that were consumed by the consumer. From the above it is clear that up to the fourth slice of bread Marginal utility is positive and Total utility increases. When the fifth slice of bread is consumed the Marginal utility is ZERO and the increase in Total utility stops. This is the point of complete satisfaction. All the extra slices of bread consumed from six slices onwards will cause dis-utility and this means that there is a negative marginal utility. Total utility starts to diminish (decrease). John will derive no further satisfaction from eating six slices of bread or more consecutively because consuming too much bread at the same time will cause negative utility. Composition of Markets Buyers Sellers Buyers are the people who buy goods and Sellers are the business enterprises who services at a price to satisfy their needs and sell goods and services at a price. wants. Sellers determine the supply of goods and Buyers determine the demand for goods services on the market. and services. 4  TYPES OF MARKETS Perfect markets Imperfect Markets World Markets Perfect Markets Definition of a perfect market A perfect market is a market structure which has a large number of buyers and sellers who are not able to influence the price. OR A perfect market is a market where prices are determined by demand and supply. OR Perfect competition occurs when none of the individual market participants can influence the price of the product. Examples of perfect markets Stock exchanges Foreign currency markets Central grain market Markets for agricultural product Wool markets Characteristics of a perfect market Many buyers and Sellers The number of buyers and sellers in the market is so large that the individual buyer or seller cannot influence the market price (price takers). The number of buyers and sellers in the market is so large that individual market participants are insignificant in relation to the market as a whole. Homogenous product: All the products sold in the specific market are homogenous, that is they are exactly the same regarding quality, appearance, etc. It makes no difference to a buyer where or from whom he/she buys the product. Freedom of entry / exit: There is complete freedom of entry and exit, that is to say the market is fully accessible. Buyers and sellers are completely free to enter or to leave the market. Entry should not be subject to any restrictions in the form of legal, financial, technological or other barriers that curtail the freedom of movement of buyers and sellers. Mobility of factors of production: All factors of production are completely mobile, in other words labour, capital and all other factors of production can move freely from one market to another. 5 Perfect information: Both buyers and sellers have full knowledge of all the prevailing market conditions. For example if one business ventured to raise its price above the market price, buyers would immediately become aware of it and would switch their purchases to businesses who still charge the lower price. No collusion: Collusion between sellers does not occur. In a perfectly competitive market, each buyer and seller acts independently from one another. Collusive practices are illegal in South Africa, according to the Competition Act 1998. Unregulated market: There is no government intervention that could affect buyers or sellers. Decisions are left to individual sellers or producers and buyers. No preferential treatment (no discrimination) Nobody is advantaged above the others Efficient transport and communication: Makes access to and from markets possible. Imperfect Markets Definition of imperfect markets An imperfect market is a market where no perfect conditions exist, one or a few sellers sell heterogeneous products and can thus influence the price of a product. Examples of Imperfect Markets Oligopolies Monopolistic competition Monopolies MTN Steers Eskom Vodacom KFC Transnet Cell C Edgars SAL Foschini Toyota / Ford / BMW 6 Monopoly Definition A monopoly is a market structure in which there is only one seller of a good or service that has no close substitutes. Examples: Eskom Transnet Characteristics of a Monopoly Number of producers - The monopolist has full control over the supply of a product, because it is the only seller - The monopoly also represents the total industry e.g. De Beers, Eskom Nature of the product - The product is unique and has no close substitutes - E.g. electricity and rail transport Economic profit - The monopoly makes a short-term loss or profit - The monopoly makes a long-term economic profit Technical superiority - A monopoly has technical advantage over potential competitors and their access to resources and technical superiority make it difficult for others to compete Access to scarce resources - A single firm owns and controls a specific scarce resource and excludes other companies from entering the market Demand curve - Monopolists are also confronted with a demand curve for their product but because they are the only supplier of the product, they can decide at what point on the demand curve they wish to be. - The monopolist is the only supplier of the product in the market - the demand curve that confronts the monopolist is that of the market as a whole. - The market demand curve which slopes downwards from left to right / graph. Production level - Once the monopolist has decided on a price, the quantity sold is determined by market demand - by reducing the price, monopolists can sell more units of the product and vice versa. - Monopolists influence the product-price combination of the product they sell without any reaction from other market participants. - Other participants cannot act because a basic requirement for the existence of a monopoly is that entry to the market is blocked. 7  Market forces - Although the monopolist is the only supplier of a product, the product is still influenced by market forces in the economy. - Consumers have limited budgets and a monopoly can therefore not demand excessive prices for the product and the monopolist product has to compete for consumer’s favour with all the other products available in the economy. - E.g. Transnet competes road, air etc. means of transport. Control over the price - A monopolist has considerable control over the market price – but demand limits it. - A monopoly does not have control over demand, so demand will influence the final market price. - A monopoly can only decide at which point on the demand curve it wants to produce. Substitutes - There are few products that have no close substitutes whatsoever. - For many years even though there was no competition for telephone services in South Africa, consumers could still use alternative forms of communication such as letters and telegrams. Favorable circumstances - Sometimes entrepreneur may enjoy favourable circumstances in a certain geographic area. - E.g. there may be only one supplier of milk in a particular town, a hardware store or hotel. - There may even be laws that protect them, e.g. Post Offices in South Africa. - Pure monopolies are a common rarity in South Africa. - Not only are substitutes available, but there is often nothing to prevent other entrepreneurs from entering the market hence what may be called a quasi-monopoly. Market information - All buyers and the single seller have full knowledge of all the current market conditions. Exploitation of consumers - The monopolist may produce fewer products at a higher price compared to businesses under perfect competition. - E.g. De Beers, because the monopolist is the only producer of the product in the market, there is always the possibility of consumer exploitation. Most governments take steps to guard against such practices and new and existing monopolies are usually well monitored. Market entry - The barriers prevent other producers from entering the market to supply the same type of product. 8  Economies of scale - These give advantages to large existing companies. - Occur when the cost per unit decreases when the output increases. - Large businesses production costs per unit are lower than those of small businesses, e.g. Eskom The geographical area - This can cause a natural barrier as well, e.g. only one holiday resort can fit on the seafront as an exclusive beach. Size of the market - Sometimes a business enjoys favourable circumstances in a certain small market. - E.g. there may be only one hardware store in a particular small town. Distinguish between Natural and Artificial monopolies Natural monopolies - High development cost are frequently a reason - the provision of electricity is often used as an example - To build a nuclear power station and transmission lines to distribute electricity costs billions of rand. - E.g. Eskom as a single business in the country that supplies electricity operates as a natural monopoly and is frequently owned and regulated by the government. Artificial monopolies - The barriers to entry are not economic in nature but artificial like patent rights which are legal and exclusive rights of a patent holder to manufacture a product using his or her unique invention. - Patents are also frequently encountered in the pharmaceutical industry. - Licensing is another way in which artificial monopoly is applied, e.g. TV and radio licenses. - licences protect operators against entry of other competitors. Oligopolies Definition The oligopoly is a type of imperfect market in which only a few producers dominate the market. Examples MTN Vodacom Cell C SAL Toyota / Ford / BMW 9 Characteristics of an Oligopoly Type of product The product is homogeneous (pure oligopoly) or differentiated (differentiated oligopoly) Entry New producers have free entry, but this is not easy since there are only a few businesses in market. Control over prices Producers generally have considerable control over the price of products. Mutual dependence Only a few businesses sell the product. Businesses are influenced by other firms’ actions. Businesses are mutually dependent on each other, that is why competitors react to price changes. A. Non Price Competition Oligopolists do not compete on price because price wars will not benefit any of them. Prices are determined by mutual, tacit agreement. Forms of non-price competition. Doing business over the internet After-sales service Loyalty rewards for customers Door-to-door deliveries Building brand loyalty and product recognition Offering additional services (free travel insurance by banks) They compete on product differentiation and efficient service. Convenience shopping, E.g. extended shopping and business hours Firms make use of advertisements to increase awareness and to attract customers towards their products. E.g. Pick ‘n Pay use extensive advertising to increase their market share. 10  B. Collusion No oligopoly can be sure of the behaviour and policy of their competitors. Businesses function in an uncertain environment. To reduce these uncertainties, businesses often collude. They agree on the prices of their products. They also decide on the quantities to be produced. It causes Higher prices Less uncertainties Makes it difficult for other businesses that want to enter the market. TWO types of collusion 1 Cartels 2 Price leadership 1 Cartels /Overt collusion It is when oligopolies collude openly and formally. Definition of a Cartel It is an organization of oligopolistic businesses that comes into existence in an industry with the specific aim of forming a collective monopoly. Cartels control the production of goods and this influences the prices of products. E.g. OPEC (oil) 2 Price leadership / Tacit collusion Formal collusion (a cartel) is usually prohibited. Collusion agreements often fail. It leads to tacit collusion. Price signals are frequently the key element to tacit collusion. One business increases its price in the hope that its rivals will increase their prices – such a firm is known as a price leader. When the other businesses follow with the increase, they are known as price followers. Price leaders are usually the strongest and most dominant business whose production cost is the lowest. E.g. steel industry, transport industry. 11 Monopolistic competition Definition Monopolistic competition is a market structure which combines certain features of monopoly and perfect competition. Examples Steers KFC Edgars Foschini Characteristics of monopolistic competition Products are not identical. Products are similar but not identical. They satisfy the same consumer needs. e.g. shoes, men’s clothing, women’s clothing, etc. Differences may be imaginary The name of the product differs but ingredients are exactly the same, e.g. medicines. Sometimes only the service of the seller differs from the others. Difference in packaging e.g. sugar and salt Only the packaging makes the difference. General characteristics of monopolistic competition (i) There are no barriers to entry or exit (entry into the market is free). (ii) The business has little control over the prices of products. (iii) Information for buyers and sellers is incomplete. (iv) Large number of diverse firms Because of product differentiation we cannot derive a demand and supply curve the same as we did under perfect competition. A single equilibrium for a single product cannot be determined, because a range of prices will apply. A graphic analysis does not focus on the industry but on the typical or representative business. The term ‘industry’ refers to all the sellers of a differentiated product in a specific product group. 12 (v)Hybrid structure Monopolistic competition is a combination of competition and a monopoly. (vi)Often it is local Occurs generally in the retail or service sector. On a national level we have, e.g. wine, clothing, furniture, etc. Locally (especially in urban areas) there are numerous examples of monopolistic competition. E.g. filling stations, pharmacies, grocery stores, etc. All these businesses have a certain amount of monopolistic power. As a result of the uniqueness of the product, or favourable location, slightly lower prices, better service. Monopolistic power is not very strong because of the availability of substitutes. A. Non-price competition It is competition on the basis of product differentiation, efficient service and by using advertisements, rather than on the basis of prices. With monopolistic competition the products are differentiated. Differentiation creates the opportunity to increase the demand for the product and to make the demand less price elastic. It is done by means of product variations and marketing campaigns. Differentiation may even be imaginary – it depends on the perception of the consumer, e.g. medicine Different trade names but it consists of the same ingredients. E.g. beauty products - try to articulate the feeling of beauty. Huge sums of money are spent on research, development and advertisements to build a loyal consumer group. Brand names play an important role. Producers try to maintain their own consumer group. e.g. Pick ‘n Pay – “No Name” products. Products are exactly the same as the known brand. The goods even originate from the same factory. 13 World markets and effects of electronics Description of the term: World markets The activity of buying or selling of goods and services in all the countries of the world. OR It is the value of the goods and services sold world-wide. Examples of commodities that are sold on the world market Coffee Oil Gold Foreign Currency All the consumers around the world pay the same price for these goods. The role of technology in world markets Technology in communication and transport link the world. Communication sources are the computer (internet and Wi-Fi), telephone, faxes, cellular phones (smart phones), etc. Communication enables us to distribute knowledge both locally and internationally. Communication made trade around the world easier. Sellers and buyers are linked and can get quickly in touch with each other. Information about prices changes in one part of the world and can easily be seen in other parts of the world. Price Description of Price Price is the value at which goods and services will be sold and purchased. Price is determined by the interaction of demand and supply. DEMAND Definition of Demand Demand refers to the quantity of goods and services that prospective buyers are willing to purchase at the given price within a given period of time. Types of demand Individual demand Individual demand is the demand of one person or one firm. 14 Market demand Market demand is the total quantity demanded by all consumers. Complementary goods and substitute goods Complementary goods are goods that are combined together to satisfy a need, e.g. CD and a CD player. They cannot be used independently. Substitute goods are goods that can replace other goods to satisfy the same need, e.g. butter and margarine. Usually the substitute good is cheaper. Demand schedule for Coca Cola at a school tuckshop PRICE OF ONE CAN OF COCA- COLA QUANTITY DEMANDED (CANS OF COCA COLA) R1.00 100 R2.00 80 R3.00 60 R4.00 40 R5.00 20 A graphical presentation of the demand for Coca Cola Demand Curve The law of demand As the price of a product increases the demand for the product decreases and as the price of the product decreases the demand for the product increases. This inverse relationship is known as the law of demand. 15 The Principle of Ceteris Paribus The demand curve is a simplified way of indicating the relationship between quantity demanded and price. This is based on the assumption that all other determinants are constant (Ceteris Paribus). Factors that influence demand The price of the product The price of related products The income of the consumer Tastes and preferences of the consumer The size of households The weather conditions Movement ALONG the demand curve Show the price - quantity demand relationship. If the price is R5, the demand for the product is 20 units, if the price drops to R3 the quantity demand will increase to 60 units and if the price decreases further to R1 the quantity demand will increase to 100 units. This represents a movement along the demand curve. SHIFT of the Demand Curve 16  A change in any factor other than price will cause the demand curve to shift to the right or the left. Shift to the right – Quantity Demanded increase For example: The market demand for umbrellas increases due to the winter rainy weather. This will cause an increase in the quantity demand for umbrellas. The demand curve will shift to the right. Shift to the left = Quantity Demanded decrease For example: The market demand for umbrellas decreases in the summer. This will cause a decrease in the quantity demand for umbrellas. The demand curve will shift to the left. Reasons why the QUANTITY DEMANDED increase – Shift to the right An increase in the income of consumers An increase in the size of the population Quantity demanded increase because of advertising, fashion, climate change, consumer tastes. Reasons why a QUANTITY DEMANDED decrease – Shift to the left A decrease in income Population size decreases Demand decreases as a result of advertising, fashions, climate change, consumer tastes. SUPPLY Define the term “Supply” Supply is the quantity of a good or service that producers plan to sell or are willing to sell at each possible price during a specific period of time. Supply Schedule PRICE OF ONE CAN OF COCA COLA QUANTITY SUPPLIED (CANS OF COCA COLA) R1.00 20 R2.00 40 R3.00 60 R4.00 80 R5.00 100 A graphical presentation of the Supply of Coca Cola at the school tuckshop SUPPLY CURVE 17 The law of supply As the price of the product increases the supply of the product will increase, and as the price of the product decreases the quantity supply will decrease. This direct relationship is known as the law of supply. The Principle of Ceteris Paribus The supply curve is a simplified way of indicating the relationship between quantity supplied and price. This is based on the assumption that all other determinants are constant (ceteris paribus). Factors that influence Quantity Supplied The price of the goods or services The price of alternative goods and services The price of factors of production The state of the technology Movement ALONG the Supply curve 18  A change in the price of a product leads to a movement along the supply curve. Show the price - quantity supplied relationship. If the price is R1, the quantity supplied of the product is 20 units. If the price increase to R3 the quantity supplied increase to 60 units and if the price increase to R5 the quantity supplied will increase to 100 units. This represents the movement along the supply curve. SHIFT of the Supply Curve A change in any factor other than price will cause the supply curve to shift to the right or the left. Shift to the right – Quantity Supplied increases For example: More businesses enter the market. More goods and services on the market. There is an increase in the quantity supplied of goods and services. The supply curve shifts to the right. Shift to the left – Quantity Supplied decreases For example: Business closes down and leaves the market. Less goods and services. There is a decrease in the quantity demanded. The supply curve shifts to the right. Reasons why the QUANTITY SUPPLIED increases – Shift to the right More businesses enter the market. The cost of factors of production decreases (e.g. wages, natural resources, etc. becomes cheaper). The use of new cost-saving and improved technology. Stable workforce with no political and workers’ disruptions. Fertile soil, favourable weather conditions, etc. 19 Reasons why a QUANTITY SUPPLIED decreases – Shift to the Left Business exits the market. The cost of factors of production increases (e.g. wages, natural resources, etc become more expensive). The use of old and inefficient and cost increasing technology. Unstable work force with many disruptions, work stoppages, labour unrest, shortage of raw materials, etc. Extreme weather conditions, e.g. droughts, storms, floods. PRICE FORMATION DEMAND AND SUPPLY SCHEDULE PRICE OF COCA COLA QUANTITY DEMANDED QUANTITY SUPPLIED (CANS OF COCA COLA) (CANS OF COCA COLA) R1.00 100 20 R2.00 80 40 R3.00 60 60 R4.00 40 80 R5.00 20 100 DEMAND AND SUPPLY CURVES The vertical axis indicates Price and the horizontal axis indicates Quantity. D = Quantity demanded for goods and services and S = Quantity supplied of goods and services. e = Equilibrium point, is where Quantity Demanded is equal to Quantity Supplied The equilibrium price = R3 and the Equilibrium quantity = 60 units of the goods. At R2 the quantity demanded for the good is 80 units and the quantity supplied of the good is 40 units. The quantity supplied is more than the quantity demanded. 20  At R2 there is an excess demand (market shortage) on the market. At R4 the quantity demanded is 40 units of the good and the quantity supplied of the goods is 80 units. The quantity supplied is more than the quantity demanded. At R4 there is an excess supply (market surplus) on the market. The functions of markets Markets bring demand and supply together BUYERS represent the DEMANDSIDE of the market and SELLERS represent the SUPPLYSIDE of the market. The three basic economic questions is WHAT? HOW? and FOR WHOM? will be produced. Markets are one way to solve the basic problem of scarcity. Markets assist to redistribute resources Prices serve as a direction indicator for both the producer and the consumer. Businesses want to maximize profits, thus they choose what to produce and sell. Households want to buy goods and services at the lowest possible prices, therefore, they influence what businesses can as well as the price it will be sold at. Markets are self-regulatory Market prices are determined by the interaction of supply and demand. There is an “invisible hand” in the economy. If prices of products increases, the demand for the product will decrease (consumers will buy less), and sellers want to sell more to increase profits. If the price of a product decreases, the demand for the product will decrease (consumers want to buy more products), and sellers will sell less because it influences their prices negatively. 21