Markets and the Economy

Role and issues of markets

A market is any place or system where people buy and sell. Prices tell everyone what is scarce. When demand is higher than supply, the price rises, buyers cut back and sellers make more. When supply is higher, the price falls. In the end, the equilibrium price is where the amount people want to buy equals the amount sellers want to sell.

Markets help in three ways: they share goods without anyone giving orders, they push firms to cut costs, and they give a reward for useful ideas.

Markets also have problems (market failure):

• Spillover costs such as pollution that nobody pays for in the price.
• Public goods such as street lights, which private firms will not supply enough of.
• Unfair sharing: poor people may not be able to buy what they need.
• Too few sellers: one big firm can charge high prices.

Economic growth

Economic growth means a country's real GDP rises over time. GDP is the value of all final goods and services made in a year. Real means we remove the effect of rising prices.

Growth rate = (this year's real GDP - last year's real GDP) / last year's real GDP x 100.

Growth comes from more workers, more machines and tools (capital), better skills, and new technology. Higher growth can raise incomes, create jobs and fund schools and hospitals. But it may also bring pollution and unequal gains, so many countries now aim for growth that lasts.

Business cycles

Growth is not smooth. The economy has a business cycle with four phases:

1. Expansion: output and jobs rise.
2. Peak (boom): demand is very high, prices may rise fast.
3. Contraction (recession): output falls, firms cut jobs. A recession is usually when GDP falls for two quarters in a row.
4. Trough: the lowest point, before recovery starts.

These swings come from changes in spending, borrowing, confidence, big shocks such as a pandemic, or a rise in oil prices.

Economic policy

Governments use policy to keep the economy steady. Their usual goals are steady growth, low unemployment, stable prices and a fair sharing of income.

• Fiscal policy: the government changes taxes and spending. In a recession it may spend more or cut taxes. In a boom it may do the opposite.
• Monetary policy: the central bank changes interest rates and money supply. Lower rates make borrowing cheaper and push spending up. Higher rates cool things down.
• Other policies: rules for competition, price controls, trade rules and support for training.

A price ceiling (a legal maximum price) that is set below the market price creates a shortage, as the 3D shows. So policies need care.

Try it

Try it in the 3D: first guess what happens to the price if demand slides to the right. Then check. Next, lower the price cap step by step and note the point where a shortage first appears.

Try it at home: next time you see a price change at a shop (ice cream in summer, vegetables after rain), say whether demand or supply changed.

Key formulas and definitions

• Equilibrium: quantity demanded = quantity supplied
• Shortage = quantity demanded - quantity supplied (at a price below equilibrium)
• Growth rate (%) = (GDP now - GDP before) / GDP before x 100
• Real GDP = nominal GDP / price index x 100

Worked examples

Common mistakes

• Moving along a curve and shifting the curve are different. A price change moves along the curve. A change in income or taste shifts the curve.
• Thinking a price ceiling always helps buyers. It makes the good cheaper but also makes it scarce.
• Mixing GDP level and GDP growth. GDP can be high while growth is low.
• Saying every fall in GDP is a recession. A recession needs a longer fall, usually two quarters.