UNIT 2

MODIFIED MARKETS AND

THE NATURE AND PURPOSE OF MARKETS
 KEY CONCEPTS
• Markets: Can be either physical or virtual and are any medium used by
buyers and sellers to interact for purposes of trade or exchange. Types of
markets include - tangible goods such as food, clothing, electronics.
Intangibles such as education and health services, financial services such as
banking, insurance and superannuation. Labour markets where physical and
mental labour are exchanged for wages and salaries and information
markets whereby consumers pay for advice e.g. legal, medical, financial.
• Markets rely on the effective functioning of the price mechanism and
competition to ensure that resources are allocated in the most optimal way.
Companies need to produce products that consumers want to buy for the
least possible price.
Key concepts continued
• The more competitive the market the more likely that consumers will
have the best outcome. Markets dominated by a few big providers
(monopoly, duopoly, oligopoly) while providing high levels of customer
service can make consumers pay more than they should be for goods and
services.
• In the last 25 years (since the advent of the internet) the virtual market –
commercial web portals have become increasingly important to modern
economies and along with containerization of ships, have lead to the
creation of the global economy.
• Sometimes markets fail or underperform. There are a whole range of
reasons why this can occur.
Key concepts continued
• Price signals are the messages that markets provide to producers
and consumers about what to produce, how to produce it and to
whom to distribute the proceeds of production. They guide the
decision-making processes in the marketplace matching buyers with
sellers. The changes in supply and demand tell producers and
consumers how they should adjust their economic behavior to
changing market conditions. e.g. a cyclone wipes out the North
Queensland banana crop causing a shortage of bananas. This forces
up the price of bananas (which are the most widely purchased fruit in
Australia). Consumers react by………….?
Types of Markets
• Markets can be characterized as factor markets (where the factors of
production) are bought & sold or product markets (where the goods and
services which are the product of the factor market) are bought and sold.
• The prices paid for the factors of production determines who receives
the goods and services produced in the market. Thus, individuals who
supply the type of labour that is in high demand will be paid high
salaries e.g.. mining engineers during the mining boom.
• Markets can be local, regional, statewide, national or international. The
market for hairdressers will only ever be local, the market for coal will
only ever be international.
Types of Markets continued…..
• Virtual Markets are situations where exchange takes place between
buyers and sellers without them needing to be in the same physical
space. Items are displayed on an on-line platform and the interaction
takes place using electronic transfers. The retail world has been
transformed by the digital platforms – from food deliveries, to
accommodation, to the labour market and the buying and selling of
everything from shoes to real estate – also termed “disrupters”.
continued….
• E-commerce allows companies to operate without “bricks and
mortar” buildings. The biggest retailer in the world – Amazon, does
not operate one shop globally.
• Some markets sell intermediate goods rather than finished products
(raw materials and components)
• Knowledge markets involve the exchange of information and
knowledge-based products e.g. stockbrokers, financial advisors
• Illegal goods (weapons, drugs, counterfeit passports, poached
animals) are sold on what is called the black market, on-line it is
known as the dark web. (Complete questions page 115)
 Business and the Market
• Markets can only satisfy consumer wants and needs if firms are
willing to supply goods and services. The motivating factor is profit.
Profit is achieved at a level of output where MR=MC (Marginal
Revenue = Marginal Cost).
• Each business will have an individual cost structure and should try and
pursue the most cost-effective methods of production. Profit is the
difference between the total cost of producing any output and the
total revenue obtained by selling the output.
• At the equilibrium position (see Figure 5.2 page 116) Q2 there is no
incentive to either increase or decrease production.
Team task – Speculation on the MR/MC
curves
• Challenge 1: As a team, estimate what the Marginal Revenue (MR)
curve would look like on a Price/Quantity graph
• Hints:
• Your marginal revenue is equal to your price.
• What will happen to price as quantity increases? Graph this relationship
• Challenge 2: As a team, estimate the Marginal Cost (MC) curve:
• Steps to solve this:
• (a) Create a graph that represents Economies of Scale (think burgers)
• (b) Create a separate graph that represents Low-Hanging Fruit Principle
• Finally, create a separate graph that combines (a) and (b)
Business and the Market continued
• Total Costs: all of the costs involved in producing a given volume of output.
• Variable Costs: the costs incurred by a firm whenever production occurs e.g.
electricity, casual wages (paid by the hour)
• Fixed Costs: Ongoing costs whether or not production occurs. e.g. rent,
council rates, salaries
• Average Cost: The cost per unit of output
• Average Revenue: the return per unit of output
• Sunk Costs: Costs that have been paid for which the firm may not get return
e.g. training staff who then resign
Business and the Market continued
• The average variable costs are likely to fall for a time as resources
(land, labour, capital & enterprise) are used more efficiently. However,
past a certain point, costs will need to rise again as production
increases or due to increases in the costs of production e.g. wage
rises thus leading to the familiar “U” shaped curves. (See figures 5.3 &
5.4 page 117)
• At all times, the marginal cost curve will intersect the average cost
curve at its lowest point. While MC is less than AC, the new average
cost will be lower; as soon as MC exceeds AC, then AC will start to
rise.(see Figure 5.5 page 118)
Average Cost Curve
Efficiency
Concepts:
• Allocative efficiency: when a country’s productive resources are used in combinations
that generate maximum benefits to the consumers.
• E.G. the Australian car industry was not an efficient use of the country’s land, labour, capital &
enterprise. Why?
• Dynamic efficiency: the ability of the economy to respond to changing consumer
demands by reallocating resources to new industries or production processes.
• Economies of Scale: the cost saving advantages that a firm gains by increasing the scale of
its production E.G. Bunnings v’s local hardware store
• Law of Diminishing Marginal Productivity: once the most efficient level of production has
been reached, adding an extra factor of production (such as a new employee) will cause a
relatively smaller increase in output than that gained from each existing factor of
production; the marginal productivity will decrease.
Efficiency: further
concepts
• Optimal outcome: the best or most favourable outcome under
a particular set of circumstances
• Pareto efficiency: the optimal allocation of resources – one
person cannot be better off without making one person worse
off
• Productive efficiency: the ability of an economy to achieve the
maximum quantity of productive resources
• Productivity: a measure of efficiency of production, expressed
in terms of the rate of output per unit of inputs
• Specialisation: the use of the factors of production to perform
narrowly defined, specific functions, such as assigning specific
production tasks to a worker e.g.

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Efficiency
continued…..
Efficiency maximizes consumer satisfaction and business
profits through:
• The more productive use of resources (no wastefulness)
• Encourages innovation in products and processes (the
new TimTam slam) also known as Research &
Development
• Perfectly competitive markets – a large number of buyers
and sellers and the opposite of monopoly and oligopoly,
are seen as encouraging the most efficient use of scarce
resources while maximizing offering consumers the best
outcomes in terms of customer service, price
competitiveness and overall satisfaction.

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The Law of Diminishing
Marginal Productivity
“Increasing the amount of any one resource (e.g. labour)
will not necessarily result in an increase in production.”
The law of economics is sometimes referred to as the
principle of diminishing returns. e.g. it is an important
principle for understanding how to make production more
efficient.
As more and more variable units of production are added
(e.g. labour) to a fixed factor of production (e.g. land) a
point will be reached whereby the output resulting from
each additional unit will begin to decline. (too many cooks
spoil the broth – the crowding effect)
Read from paragraph 2 page 121

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Efficiency continued

Resources are being used in the most efficient ways when a firm’s
average costs are equal to its marginal costs (AC=MC), resulting in
goods and services being produced at the lowest possible cost.
Productive efficiency: achieved when a firm achieves the maximum
quantity of output from a given quantity of productive resources.
(read last two paragraphs P122 and see Figure 5.7)
Productivity: firms must gain maximum productivity. They do this by
focusing on the volume of output produced from the given inputs.
Improving productivity reduces costs. MFP (multifactor productivity
or all of the factors of production).
MFP = output ÷ all inputs
or it can focus on improvement in a single factor productivity or SFP

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Specialisation

Firms increase their productivity through specialisation of the factors of

production.
Specialisation of land or industry: involves firms focusing on producing a
narrow range of goods e.g. cattle property. Businesses will often cluster
together in an urban environment either because of zoning or because of
access to ports, rail facilities, highways, major intersections.
Specialisation of labour: can be referred to as ‘division of labour’. Has been a
feature since the industrial revolution. Advances in technology and education
have increasingly lead to the specialisation of labour e.g. hospital staff
Specialisation of capital: concurrently developed with specialisation of labour.
Development of specific machinery or technology to use in specific industries.
In many instances specialized capital has replaced specialized labour – and will
continue to do so
Specialisation of enterprise: Entrepreneurs (who are owners or managers)
develop specialized knowledge and skills to enable them to work in their
specific area of economic activity

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Economies of Scale
There are both economies and miseconomies associated with large scale production.

• Firms can avoid the law of diminishing marginal productivity simply by increasing
their scale of production. As a firm grows, there are benefits to be gained called
economies of scale, because it results in lower costs per unit as production
increases.

• Internal economies are derived from a firm growing because growth eliminates
wasted capacity (often found in small scale enterprises). Further, it can increase
specialisation among employees reducing the average costs of the firm in the
medium-long term.

• External economies are those benefits that accrue to all firms within an industry or
society as the result of the existence of the industry. In Australia this is
demonstrated by the existence of mining towns that would not have existed with
the mine. e.g. Mt Isa, Broken Hill, Moranbah – roads, schools, railways, shopping
facilities

• Internal diseconomies are those negative problems that occur when firms increase
in size e.g. communication or alienation of staff in a large organization.

• External diseconomies occurs when firms create negative problems as a result of

their economic activity e.g. air or noise pollution from a factory, traffic congestion

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Market Structures
• Perfect Competition: a theoretical market structure in which the many
buyers and sellers trade a homogeneous product, in which there are no
barriers to entry into the market and into which all of the producers are
price takers.
• Monopolistic competition: the market situation in which a large number
of buyers and sellers are exchanging similar but not identical products.
(Clothing – virtual & bricks & mortar)
• Oligopoly: a market situation in which a small number of firms are selling
similar but not identical products. (Duopoly – two dominant companies)
• Monopoly: a market situation in which one seller sells a product for
which there is no close substitute, allowing it to be the price setter
• Natural monopoly: arises when the costs of production are so high they
are minimized when one firm controls the market, often a government
owned enterprise. e.g. railways
• Read pages 131-137

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Market Outcomes

• Adam Smith would tell us that the best outcomes for

consumers will always be delivered where there are high
levels of consumer sovereignty and the market structure is
as close as possible to perfect competition. However, this
may not always be the case. In instances where firms can
exploit economies of scale, consumers may benefit more
than if many small firms are competing.
• High levels of competition do result in lower prices, better
service and increased innovation, however, in the real world
it is not always possible for the price mechanism to operate
freely. Depending on the country, there can be high levels of
government intervention which can be aimed at improving
market behavior (e.g. Royal Commission into Banking) or
ensuring a socially optimal outcome e.g. reduced fares on
public transport

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Market Failure

Concepts
• Asymmetric information: the situation where one party has better knowledge of the
economic transaction than the other e.g. consumers are generally less informed about a
product than sellers
• Common property goods: no one has defined property rights e.g. the ocean, the wilderness,
the beach (in Australia)
• Demerit good: a private good or service with negative externalities e.g. soft drink, cigarettes
• Merit good/public goods: a good or service with positive externalities that can be
underproduced by the private sector or fail to attract private sector suppliers. E.g. public
transport
• Factor mobility: the ability of the FOP to move to where they can attract a high level of
economic efficiency
• The tragedy of the commons: the over-use or destruction of common property because it has
no price and so markets do not ration its consumption i.e. Cradle Mountain in Tasmania/
Great Barrier Reef
• (read pages 139-145 Q’s 1-5)