The Principles Of Economics

Published Date: 02 Nov 2017

Name

University

Course Code

Q No 1.

Market mechanism

"The process by which a market solves a problem of allocating resources, especially that of deciding how much of a good or service should be produced, but other such problems as well. The market mechanism is an alternative, for example, to having such decisions made by government."

Source: University of Michigan, Deardoff’s Glossary of International Economics

Types of markets:

Following are the four main types of markets:

1.    Monopoly

2.   Oligopoly

3.    Monopolistic competition

4.   Perfect competition

Monopoly:

A monopolistic market is a market that features one, if not all, of the characters of a monopoly such as high price levels, supply constraints, or multiple barriers to entry. Because this type of market comprises of individual supplier, consumers would have no choice but to purchase only from this individual supplier. Without suitable legislation or controls or rules, this individual supplier possesses the power to raise prices without adversely affecting demand for its products/services. This particular type of market stands in contrast to a perfectly competitive market. (www.investopedia.com). For example Etisalat formed a monopolistic telecommunication market. In this monopolistic scenario the demand remains the same with the increase in price.

Oligopoly:

An oligopoly is a market structure in which a small number of firms dominate. When a market is shared between a few firms, it is said to be highly concentrated. Although only a few firms dominate, it may be possible that many of the small firms may also operate in the market. For example, major airlines like British Airways and Air France operate their routes with only a few close competitors, but there are also many small airlines catering for the holidaymaker or offering specialist services for its clients. (www.economicsonline.co.uk).

Monopolistic competition:

This kind of market refers to a market scenario with a relatively large number of sellers selling similar but not identical products. Following are some of the characteristics of a monopolistic competition market:

a. Every firm has a small percentage of the total market.

b. Collusion is almost not possible with so many firms.

c. Firms act independently with no feeling of mutual interdependence among the sellers. The actions of one rival are unnoticed by the others. ( The American School of Guatemala, 2012)

Perfect competition:

A situation where there are many firms competing in the market, there is lot of competition and the firm producing the best quality goods and services at lowest price will be successful. (Marshall).The following are some of the main features of a perfect competitive market 1. Many sellers and buyers 2. Homogeneous products 3. Absence of government intervention 4. Almost perfect information available of the market etc. (Salter, 2009). The Panzar–Rosse H-statistics suggest that banks in Kuwait, Saudi Arabia and the UAE operate under perfect competition whereas banks in Bahrain and Qatar operate under conditions of monopolistic competition. (Saeed Al-Muharrami, 2006)

Q No 2.

Aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing to sell at a given price level in an economy. For example supply of Honda cars. The firm plans to sell the cars according to a given price level in the UAE economy. However the aggregate supply curve is defined in terms of the price level. Increase in the price level increases the price that Honda can get for its products, therefore, make more cars. However, an increase in the price would also have another effect; it would also ultimately lead to increase in input prices, which holding other things constant would cause Honda to cut back. So, there is a little uncertainty as to whether the economy will supply more real GDP as the price level rises. (SparkNotes Editors). The total amount of goods and services demanded in the economy at a given overall price level and in a given time period is aggregate demand. It is represented by the aggregate-demand curve, which describes the relationship between price levels and the quantity of output that firms are willing to provide. Normally there is a negative relationship between aggregate demand and the price level. Also known as "total spending". (Invetopedia US Inc.). Like the demand and supply for individual goods and services, the aggregate demand and aggregate supply for an economy can be represented by a schedule or a curve. The aggregate demand curve represents the total quantity of all goods (and services) demanded by the economy at different price levels. (diffsnote).An example of an aggregate demand curve

http://media.wiley.com/Lux/43/9643.nfg001.jpg

The vertical axis represents the price level of all final goods and services. The aggregate price level is measured by either the GDP deflator or the CPI. The horizontal axis represents the real quantity of all goods and services purchased as measured by the level of real GDP. Notice that the aggregate demand curve, AD, like the demand curves for individual goods, is downward sloping, implying that there is an inverse relationship between the price level and the quantity demanded of real GDP.

The demand curve for an individual good is drawn under the assumption that the prices of other goods remain constant and the assumption that buyers' incomes remain constant. As the price of cars rises, the demand for cars falls because the relative price of other goods is lower and because buyers' real incomes will be reduced if they purchase cars at the higher price. The aggregate demand curve, however, is defined in terms of the price level. A change in the price level implies that many prices are changing, including the wages paid to workers. As wages change, so do incomes. Consequently, it is not possible to assume that prices and incomes remain constant in the construction of the aggregate demand curve. Hence, one cannot explain the downward slope of the aggregate demand curve using the same reasoning given for the downward-sloping individual product demand curves.

Q No 3.

Factors that Effect Aggregate Supply and Aggregate Demand

Factors that Effect Aggregate Supply and Aggregate Demand

Aggregate Demand

Aggregate Supply

1. Income

(+)

1. Costs

(a) Labor (wages)

(b) Resource

(–)

2. Wealth

(+)

2. Investment (prior)

(+)

3. Population

(+)

3. Productivity

(+)

4. Interest rates

(–)

4. Interest rates

(+)

5. Credit availability

(+)

5. Credit availability

(+)

6. Government demand

(+)

6. Foreign supply

(–)

7. Taxation

(–)

7. Taxation

(–)

8. Foreign demand

(+)

9. Investment

(+)

10. Expectations

(a) Inflationary

(b) Income

(c) Wealth

(d) Interest rate

(+)

(+)

(+)

(+)

(+): An increase in this factor causes the curve to shift right.

(–): An increase in this factor causes the curve to shift left.

The changes in equilibrium in the Aggregate Supply and Aggregate Demand model occur due to changes in the variables that effect supply and demand. The variables that are likely to effect supply or demand are listed above. The signs (+) or (-) shows the assumed direction of control. The relationship between Aggregate Supply, Aggregate Demand and price are represented by the slope of the AS and AD curves; changes in all other variables cause the curves to shift right or left.