LEARNING OBJECTIVES
What you will be able to do
- compare market, mixed and planned systems
- analyse demand, supply and equilibrium changes
- calculate and interpret price elasticity
- evaluate market failure and government intervention
AT A GLANCE
INTRODUCTION · THE BIG IDEA
Use demand, supply, elasticity and market intervention to explain how resources are allocated.
An economic system answers what, how and for whom to produce. In markets, prices transmit information and incentives between consumers and producers.
Demand and supply diagrams are models: a curve shift changes equilibrium, while elasticity shows the size of response. Government intervention may improve outcomes but can create new costs or distortions.
SECTION 01
Economic systems and the price mechanism
Market systems use consumer choice, private property and profit incentives. Planned systems rely on state decisions. Mixed economies combine markets with government provision and regulation.
Price acts as a rationing device when demand exceeds supply, a signal of changing scarcity and an incentive for producers. Competition can encourage efficiency and choice, but markets may underprovide merit and public goods or ignore external costs.
| Feature | Market strength | Possible weakness |
|---|---|---|
| Consumer choice | responds to preferences | income determines purchasing power |
| Profit incentive | encourages innovation | may ignore social cost |
| State provision | can improve access | tax cost and possible inefficiency |
SECTION 02
Demand, supply and equilibrium
Demand is willingness and ability to buy at different prices; supply is willingness and ability to sell. A price change causes movement along a curve. Income, taste, population, related-product prices and expectations can shift demand; cost, technology, tax, subsidy, weather and producer numbers can shift supply.
A shortage pushes price upward and a surplus pushes it downward. To analyse a change, identify the correct curve, shift direction, then state the new equilibrium price and quantity.
SECTION 03
Price elasticity of demand and supply
Price elasticity of demand (PED) measures responsiveness of quantity demanded to price. Demand is elastic when the percentage quantity response is larger than the percentage price change. Substitutes, luxury status, time and small budget share tend to affect elasticity.
Price elasticity of supply (PES) measures producers' responsiveness. Spare capacity, inventory, production time and ease of moving resources usually make supply more elastic. With elastic demand, a price fall tends to raise total revenue; with inelastic demand, a price rise tends to raise it.
Interpreting PED
- Price rises by 10%.
- Quantity demanded falls by 25%.
- PED = −25% ÷ 10% = −2.5; use magnitude 2.5 for classification.
Answer: Demand is price elastic, so the price rise is likely to reduce total revenue, other things equal.
SECTION 04
Market failure and intervention
External costs such as pollution make social cost exceed private cost; external benefits such as vaccination make social benefit exceed private benefit. Public goods are non-excludable and non-rival, so free riding discourages private provision. Information failure and monopoly power also misallocate resources.
Governments may use indirect taxes, subsidies, regulation, information, state provision, price controls and property rights. A maximum price below equilibrium may improve affordability but create shortage; a minimum price above equilibrium may protect income but create surplus.
Intervention has opportunity cost and may suffer information gaps, administrative cost, evasion or unintended incentives—government failure.
| Problem | Possible policy | Possible drawback |
|---|---|---|
| Negative externality | tax or regulation | higher price; enforcement cost |
| Positive externality | subsidy or provision | taxpayer cost |
| Low affordability | maximum price | shortage and black market |
QUICK CHAPTER SUMMARY
The ideas to carry forward
- Prices coordinate choices in market systems.
- Curve shifts change equilibrium; own-price changes cause movements.
- Elasticity measures responsiveness, not direction alone.
- Intervention can correct market failure but may also fail.
QUICK REVISION CHECKLIST
Can you do each of these without your notes?
- compare market, mixed and planned systems
- analyse demand, supply and equilibrium changes
- calculate and interpret price elasticity
- evaluate market failure and government intervention