Marketing: Demand and Supply, Market Structure, Market Failure

The role of the market

Determining solutions to the economic problem

The economic problem is the unlimited wants that consumers have with limited resources available. Three questions need to be asked when determining a decision, which are “what to produce?” “How to produce?” and “who will receive the goods and services?

The importance of relative price in reflecting opportunity costs in the goods and services and factor markets

The market price paid by consumers for goods and services reflect opportunity costs. Markets for productive resources (natural, human and capital), known as factor markets, determine the opportunity costs of productive resources. Market price can also be used to help determine the best way to allocate scarce resources.

Demand and supply

Demand (demand is the willingness to buy coupled with the ability to buy it. Goods that are demanded must give satisfaction (or utility))

• Law of demand- the lower the product”s price, the greater the quantity that people will buy, assuming ceteris paribus.
• Individual demand- a demand by individuals for goods and services
• Market demand- demand by all consumers for a particular good or service.
• The demand curve- shows the relationship between prices, quantity and demand for a product in a graphical form.

Factors affecting demand:

• Price- generally the higher the price, the lower the demand for a good or service
• Income- the higher the income, the more an individual/household can consume
• Population- a growing population means there are more potential consumers
• Tastes- influences what the consumer wants to buy
• Prices of substitutes and complements- a substitute is a product that could be used in place of another, a complement is a good that is used in conjunction with another.
• Expected future prices- if prices are expected to decrease, consumers may choose to delay the purchase for the good, as it reduces opportunity costs. However, if prices are expected to increase, consumers may purchase moor goods now with the assistance of credit.

Movements along the demand curve

Contraction in demand is influenced by the price of the product rising.

Expansion in demand is influenced by the reduction in the price for a good.

Shifts of the demand curve

An increase in demand is influence by external factors (i.e. factor other than price). It is when the demand curve is shifted to the right.

A decrease in demand is influence by external factors (i.e. factor other than price). It is when the curve is shifted to the left.

Supply (the amount of good a firm will sell at a certain price)

• Law of supply- states that as price raises quantity supplied rises or as price falls, quantity supplied will fall.
• Individual supply- supply by an individual firm of a particular good or service
• Market supply- supply by all firms of a particular good or service
• The supply curve- shows the relationship between prices, quantity and supply in graphical form

Factors affecting supply:

• Price/cost of factors of production- reduced cost of production will result in an increase in supply
• Prices of substitutes and complements- the price of other goods may encourage producers to switch to production of these goods resulting in reduced supply of the original good.
• Expected future prices- this can influence the production decisions of firms. Expected rises in prices can cause firms to raise production and increase supply.
• Number of suppliers- an increase in the number if sellers are likely to result in increase in supply.
• Technology- new technology will lower cost of production and increase supply.

Shifts of the supply curve

• Movement to equilibrium – If the prices of goods or services are higher or lower than equilibrium, disequilibrium occurs. If prices are above equilibrium, supply will be greater than demand, that is, there will be an excess of goods that are left unsold, and forcing the prices to be lower until the surplus is removed [see below diagram]. If prices are below equilibrium, the demand for a good exceeds the supply. Producers then can sell their goods for higher prices until equilibrium is reached [see below diagram].
• Effects of changes in supply and/or demand on equilibrium market price and quantity through the use of diagrams
• Effects of changing levels of competition and market power on price and output – If the level of competition decreases, a firm will have increased market power. This increase in market power allows them to have more influence over the market price. A firm that has no competition (a monopoly) can increase the price of a product by reducing output.

Alternatives to market solutions – the role of government

• Price ceilings, price floors – The government can intervene with the prices for goods and services by placing a price floor or price ceiling. A price floor is when the government sets a minimum price for a good, whilst a price ceiling is when the government sets a maximum price for a good. A price ceiling can be set to make a good or service more accessible to the community, whilst a price floor can be placed to guarantee producers a minimum price for their output.
• Market failure – situation where the market fails to allocate resources efficiently. It occurs with the provision of merit goods, public goods and externality benefits and are costs associated with the production and/or consumption of certain goods.
• Merit goods, e.g. education – These are commodities, which are regarded as being socially desirable, irrespective of consumer’s preferences. The merit goods of society justify the government subsidizing the provision of these goods and services.
• Public goods – there are two important features of these goods. They are that i) they are indivisible in consumption (i.e. one person’s consumption does not reduce the amount available, usually a non-rival or collective good) and ii) they are accessible to everyone. Public goods are usually too costly for individuals to purchase, and is usually regulated by the government.
• Externalities – An externality cost is a cost, which is not, reflected in the price for a product but on other people eg pollution. A firm, which produces pollution, does not have to pay for it, nor do they sell it to consumers. Instead, communities pay for it in illnesses, loss of ability to do activities that are usually done everyday etc.

Price elasticity of demand

Significance of price elasticity of demand – market research

Firm’s marketing department researches the possible outcomes of a price change. If the good is elastic, a price rise could cause the demand for that product to be reduced. If the good were inelastic, a price rise would have little affect on the demand for that product.

Price elasticity

Elastic – a little change in price leads to a large change in quantity

Inelastic – a large change in price leads to little change in quantity

Unit elastic – change in price is proportionate change in quantity

Calculation of elasticity using total outlay method

Total Outlay = Price x Quantity

Falling – Relatively elastic

Unchanged – Unit elasticity

Rising – Relatively inelasticity

Factors affecting elasticity of demand

• If the Good is a luxury good or necessity – Luxury goods tend to have an elastic demand and necessities tend to be inelastic
• The existence of substitutes – Where substitutes exist, demand tends to be elastic
• Whether the item constitutes a large or small proportion of a personal income – The demand for expensive items tends to be elastic whereas demand for cheaper items tends to be inelastic
• The length of time since a price change – Demand becomes more elastic the greater the length of time since the price change. This is because consumers have time to respond to price changes and switch products.

Price elasticity of supply

• Elastic supply – the quantity supplied to the market changes significantly when the price changes a little
• Inelastic supply – a small reaction in the quantity supplied when the price changes a little.

Factors affecting supply

• Time lags after a price change. Following a price increase a producer in the short run is restricted in their attempts to increase production. Supply will be virtually perfectly inelastic. This is because producers can only increase production by working their factors of production harder (labour + Capital). In the long run, the producer can increase inputs including the size of the production plant or capital to therefore increase production, in response to a price change, therefore making supply elastic.
• Ability to hold and Store Stock. The ability to hold stock will affect the ease at which producers can respond to price changes. The easier it is to hold stock the more elastic the supply. Whereas perishable goods is relatively inelastic.
• Excess capacity. If a firm is not operating with its existing resources at full capacity, supply is will elastic. This is because they now have allowance to respond quickly to any price increase simply by using existing resources more intensively, as opposed to half capacity.

Variations in competition

Market structures

Pure (perfect) Competition – A market structure where there are many buyers and sellers producing homogenous goods or services.

Market conditions characterized by:

• Many firms that is relatively small
• Homogeneous (identical) products
• No barriers to entry
• Sellers can sell all they can at market price
• Advertising is pointless
• Firms are price takers-market equilibrium price (consumers can leave and go to competition selling at lower prices) – Eg. Fish Markets, Fruit & Vege markets.
• Monopoly – A market structure where there is one large firm producing a unique product.

Market conditions characterized by:

• One firm selling product with NO competition
• No close substitutes
• Extremely high barriers to entry (govt regulations, high establishment costs)
• Firms are the price setter as it is the only firm that can provide the product/service
• Simple advertising (no need to “win” over consumers from competitors) – Eg. Sydney Water, Australia Post

Monopolistic Competition

• Market structure where there are many sellers producing differentiated products. No significant barriers to entry.
• Many firms that is relatively small
• Products are slightly differentiated – not identical thus giving firms some degree of price setting power
• Small barriers to entry – existing firms may have developed brand loyalty as result of product differentiation
• Advertising is important – Eg. Motels, Restaurants

Oligopoly

• Market structure consisting of a few large firms producing slightly differentiated products.
• Few relatively large firms each with significant share of market
• Similar but differentiated products
• High barriers to entry
• Sellers can sell all they can at market price
• Firms monitor behaviour of rival firms – compete through advertising rather than price-cutting – Eg. Supermarkets, Telecommunication