2.3

• When analysing markets, a range of assumptions are made about the rationality of economic agents involved in the transactions
• The Wealth of Nations was written

  1776
• Rational


  (in classical economic theory) economic agents are able to consider the outcome of their choices and recognise the net benefits of each one
• Rational agents


  • Consumers
  • Producers
  • Workers
  • Governments
• Consumers act rationally by


  Maximising their utility
• Producers act rationally by


  Selling goods/services in a way that maximises their profits
• Workers act rationally by


  Balancing welfare at work with consideration of both pay and benefits
• Governments act rationally by


  Placing the interests of the people they serve first in order to maximise their welfare
• Groups assumed to act rationally


  • Consumers
  • Producers
  • Workers
  • Governments
• Rationality in classical economic theory is a flawed assumption as people usually don't act rationally
• A firm increases advertising

  Demand curve shifts right
• Demand curve shifting right

  Increases the equilibrium price and quantity
• Marginal utility


  The additional utility (satisfaction) gained from the consumption of an additional product
• If you add up marginal utility for each unit you get total utility
• In a market system, prices for goods/services are determined by the interaction of demand and supply
• Market


  Any place that brings buyers and sellers together
• Types of markets


  • Physical (e.g. McDonald's)
  • Virtual (e.g. eBay)
• Market equilibrium process


  1. Buyers and sellers meet to trade at an agreed price

  2. If they do not agree on the price then they do not purchase the good/service and are exercising their consumer sovereignty

  3. Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties
• Equilibrium


  Occurs when demand = supply
• Equilibrium price


  The price at which sellers are clearing (selling) their stock at an acceptable rate
• Disequilibrium


  Occurs whenever there is excess demand or excess supply in a market
• Excess demand


  Demand is greater than supply
• Excess supply


  Supply is greater than demand
• Market response to excess demand

  1. Sellers gradually raise prices

  2. This causes a contraction in quantity demanded as some buyers no longer desire the good/service at a higher price

  3. This causes an extension in quantity supplied as other sellers are more incentivised to supply at higher prices

  4. The market will arrive at a position of equilibrium
• Market response to excess supply

  1. Sellers gradually lower prices

  2. This causes a contraction in quantity supplied as some sellers no longer desire to supply

  3. This causes an extension in quantity demanded as buyers are more willing to purchase at lower prices

  4. The market will arrive at a position of equilibrium