How Markets Functions - Essay Example

? Topic: How Market Functions Table of Contents I. Introduction……………………………………………………………….. 3 A) Overview of the essay……………………………………………………….3 B) Definition of terminologies…………………………………………………..3 II. Economic problems…………………………………………………………3-4 A) Various Economic systems-…………………………………………..4 i. Socialism, ii. Communism iii. Capitalism and iv. Mixed economy B) Aims and determinants of demand……………………………………...5-7 III. Issues from the wall street journal-Examined labor and stock markets……..9-10 IV. Conclusion and recommendations…………………………………………..12 Introduction The US labor market is experiencing higher unemployment rates. Prices are continually souring high and interest on mortgages rising .These situations can also be addressed by critically examining how the market elements interact. Thus, markets are institutions that interact to bring buyers together and sellers to effect exchanges. In a free market economy there is interaction of demand and supply forces to bring about equilibrium in the in the market. The paper will attempt to highlight economic systems; forces of demand and supply; economic issues in the wall street journal and finally a brief conclusion. Basic Terminologies Scarcity is a state where wants exceeds available resources while an opportunity cost is the foregone alternative that is actually the cost of what is chosen. An allocative efficiency is a situation where resources are utilized without waste. Cost benefit analysis is where resources are selected on basis benefit as weighed against costs. A resource is any asset that will satisfy human wants. An economic problem arises due to availability of insufficient resources to satisfy all unlimited human needs. The challenge then is how to establish products and to allocate the factors of production of land, labor capital and entrepreneurship to attain maximum production, when is to produce and for whom. This scarcity necessitates the need for consumers to make a choice to satisfy their demand due to their limited incomes. Different economic models place choice in various economic systems. The figure below offers a typical example of an opportunity cost. Assuming that a country produces only two goods, A and B, it has to make a choice in the allocation of resources to attain maximum production efficiency and to achieve maximum utility. Fig 1 Production Possibility Frontier (ppf) Possibility Frontier (ppf) Capital Goods A M E A K 0 N B Consumer goods Consumer goods The curve AB can be attained if the resources employed in production are efficiently utilized with the existing state of technology. Suppose country X decides to produce only two goods: Capital goods and consumer goods as shown on the ppf AB. If it decides to produce (OA) units of A, it will have zero OB units of A. Thus OA goods are the opportunity cost of OB goods. Occasionally, country X will allocate resources to produce little of OA and OB to maximize utility as depicted at E. In real life situations, people will have to make choices between two competing alternatives. For instance, students making choices on either continuing with studies or earning, consumers to choose good A at the expense of good B or vice versa. One alternative becomes an opportunity cost for the other. Various Economic Systems Economic systems are mechanisms through which an economy works. For instance, there is socialism in which policies regarding allocation, production and distribution are left in the hand of producers and government. Others are capitalism, communism and mixed economy which functions differently. Goals of Microeconomics Micro-economics analyzes market failure, describes theoretical conditions related to perfect conditions and how these anomalies can be corrected. The theory of demand and supply is based on the assumption that markets are perfectly competitive. This implies that there are many sellers and buyers in the market none of which is able to influence prices. However, such an ideal situation rarely occurs as occasionally some sellers hoard goods that later influence prices. Micro economic approaches also remain relevant in several real life situation such as in labor that examines wages, employment and labor market dynamics; urban economics, which examines challenges faced by cities, such as pollution, poverty and housing; political economics which looks at the economic policies taken by the government; public economics which examines the design of government tax and expenditure policies among others. The paper has critically examined some of the decisions taken by various economic agents (individuals, firms and the government) in satisfying limitless needs using available, inadequate resources. First, the paper has looked at the determinants of both demand and supply and how equilibrium is attained in market. Then it has also attempted to illustrate a few examples of how markets play a critical function in allocation, distribution and consumptions of these limited resources. Determinants of Demand and Supply Determinants of demand other than the price of goods include: consumer’s income(Y), tastes and preferences (t), prices of other related goods and services (complementary and substitutes), consumers expectation of changes in future prices and population which constitutes the potential consumers. On the other hand, determinants supply includes production costs, state of technology, price of related goods, firm’s expectorations about future changes in price and the number of suppliers in the market. These factors cause shifts in both demand and supply curves. Fig 2 shows market for a particular good(s). Assuming that the good in question is a normal good, the law of demand applies. At higher prices P0, quantity of goods demanded is Q0. When prices drops from P2 to P1, quantity demanded increases from Q0 to Q1 as shown. The reverse is true for normal goods. Fig 2 Price D S $ E P0 G P1 D D 0 Q0 Q1 Quantity An increase in price will cause decease in quantity demanded and vice verse cateris peribus. However, a change in other determinants other than the price will cause a shift in demand as shown below in fig 3.An example is an increase in consumer’s income. Assuming the good is normal; an increase in consumer’s income increases his purchasing power thus purchasing more of quantity even with an increase in price from P1 to P2, as shown in fig 3.The equilibrium shifts from d to e, as quantity moves from Q0 to Q1 Fig 3 D1 Price $ p2 D e P1 d f S D D1 0 Q0 Q1 Q2 Quantity In addition, there are cases of economic shortages, which occur in the market as a result of market prices being higher than the equilibrium prices. It affects the budget set of the consumer besides posing negative social externalities. Fig4 Price Dl D2 SL P2 Surplus E P0 P1 Shortages D2 SL Dl Q1 QE Q2 Quantity In fig 4 above, there is an economic inefficiency with markets experiencing shortages and surpluses. The above situation can be applicable in both labor and products markets. In products markets, if the sellers are offering goods at a lower price (P1) than the equilibrium price (P0), consumers respond by purchasing more (Q2) and vice versa. The labor market sales have dropped due to rising interest rates and have led to lose of confidence in making substantial investments. Y-T= C+S+I, =f(r) where I investment and r are interest rates. Yd =C+S, Y income, T taxes C consumption I investment Yd disposable income after taxation Unemployment is a critical issue examined in the article. A survey carried out recently shows that more than two million people will lose their jobs, if policies meant to remedy the dull economic situation are delayed as shown in the diagram below. Fig5 It means that failure by the federal government to enact laws, US labor market shall experience excess labor supply than demanded to fuel unemployment in the country. This has both financial and social costs to the consumers such as poor living conditions, increase in crime rates and psychological problems at the household level. Fig6 Price Dl D2 SL P2 Surplus E P0 P1 Shortages D2 SL Dl Q1 QE Q2 Quantity In the fig 6 above, the wage P1 is above the equilibrium wage P0. This attracts many people to look for jobs in firms. However, firms are unwilling to hire as the labor costs are higher than the market going labor costs. It results in excess people without jobs resulting in unemployment as shown in triangle E. The reverse holds cateris peribus. In the Housing markets, the US officials are pushing for a plan to help refinance mortgages in order to assist citizens ease the housing problem. Consumers have little to save, therefore, leave little income for investment as much is devoted to these basic amenities like rent, food and clothing. Us recession is on ground and the GDP has declined as shown in figure 7 below..This implies that consumers have to make choices to maximize the utility. Fig7 On the international scene, China has a comparative advantage over the US as evidenced in the trade gap and the growth of real GDP. This is attributed to differences in the economic policies pursued by the two countries. Conclusion The paper has examined how market functions depending on the structure it adopts. Notes 1. Department of labor. These are labor statistic adapted from the labor statics, 2011.accesed from the web on 19th oct.2011 2. Department of commerce and Financial markets, 2011.accessed from the web on 19th oct.2011 on www.wsj.com> 3. Parkin.M. Economics. Canada in the global environ ment:Toront,Addison-wesley,1997 4. Wall street is a collection of articles about a wide variety of topics ranging from social life to business to politics that that affect the world currently. Read More