Which of the following statements are positive and which are normative? Explain.

1) The rate of inflation has fallen below 10 per cent per annum.

2) Because inflation has fallen the government should now expand its activity.

3) The level of income is higher in the UK than in the Soviet Union.

4) People in the UK are happier than people in the Soviet Union.

5) People should not be encouraged to drink and taxes must be kept high on alcoholic beverages.

6) The price of oil more than tripled between 1973 and 1974.

7) In 1984, the poor countries of the world received less than their fair share of world income.

8) The world distribution of income is too unjust, with poor countries having 61 per cent of the world’s population, but receiving only 6 per cent of world income.

9) In the early 1980s, most Western economies faced sharp rises in the aggregate unemployment rate.

10) The UK government ought to introduce policies to reduce the unemployment rate.

11) Smoking is antisocial and should be discouraged.

12) The imposition of higher taxes on tobacco will discourage smoking.

13) The economy of Hong Kong is closer to a free market system than that of Albania.

The Market

We already defined markets in a very general way as arrangements through which prices guide resource allocation. We now adopt a narrower definition. A market is a set of arrangements by which buyers and sellers are in contact to exchange goods or services.

Some markets (shops and fruit stalls) physically bring together the buyer and the seller. Other markets (the London Stock Exchange) operate chiefly through intermediaries (stockbrokers) who transact business on behalf of clients. In supermarkets, sellers choose the price, stock the shelves, and leave customers to choose whether or not to make a purchase. Antique auctions force buyers to bid against each other with the seller taking a passive role.

Although superficially different, these markets perform the same economic function. They determine prices that ensure that the quantity people wish to buy equals the quantity people wish to sell. Price and quantity cannot be considered separately. In establishing that the price of a Rolls Royce is ten times the price of a small Ford, the market for motor cars simultaneously ensures that production and sales of small Fords will greatly exceed the production and sales of Rolls Royse. These prices guide society in choosing what, how, and for whom to purchase.

To understand this process more fully, we require a model of a typical market. The essential features on which such a model must concentrate are demand, the behaviour of buyers, and supply, the behaviour of sellers. It will then be possible to study the interaction of these forces to see how a market works in practice.

Demand is the quantity of a good buyers wish to purchase at each conceivable price. Thus demand is not a particular quantity, such as six bars of chocolate, but rather a full description of the quantity of chocolate the buyer would purchase at each and every price which might be charged. The first column of Table 1 shows a range of prices for bars of chocolate. The second column shows the quantities that might be demanded at these prices. Even when chocolate is free, only a finite amount will be wanted. People get sick from eating too much chocolate. As the price of chocolate rises, the quantity demanded falls, other things equal. We have assumed that nobody will buy any chocolate when the price is more than £0.40 per bar. Taken together, columns (1) and (2) describe the demand for chocolate as a function of its price.

TABLE 1. THE DEMAND FOR AND SUPPLY OF CHOCOLATE

Price (£ / bar)	Demand (million bars/ year)	Supply (million bars/ year)
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70

 

Supply is the quantity of a good sellers wish to sell at each conceivable price. Again, supply is not a particular quantity but a complete description of the quantity that sellers would like to sell at each and every possible price. The third column of Table 2-1 shows how much chocolate sellers wish to sell at each price. Chocolate cannot be produced for nothing. Nobody would wish to supply if they receive a zero price. In our example, it takes a price of at least £0.20 per bar before there is any incentive to supply chocolate. At higher prices it becomes increasingly lucrative to supply chocolate bars and there is a corresponding increase in the quantity of bars that would be supplied. Taken together, columns (1) and (3) describe the supply of chocolate bars as a function of their price.

Notice the distinction between demand and the quantity demanded. Demand describes the behaviour of buyers at every price. At a particular price such as £0.30, there is a particular quantity demanded, namely 80 million bars/year. The term 'quantity demanded' makes sense only in relation to a particular price. A similar distinction applies to supply and quantity supplied.

In everyday language, we would say that when the demand for football tickets exceeds their supply some people will not get into the ground. Economists must be more precise. At the price charged for tickets, the quantity demanded exceeded the quantity supplied. Although the size of the ground sets an upper limit on the quantity of tickets that can be supplied, a higher ticket price would have reduced the quantity demanded, perhaps leaving empty space in the ground. Yet there has been no change in demand, the schedule describing how many people want admission at each possible ticket price. The quantity demanded has changed because the price has changed.

As in our discussion of tube fares in the previous chapter, we must recognize that the demand schedule relating price and quantity demanded and the supply schedule relating price and quantity supplied are each constructed on the assumption of 'other things equal'. In the demand for tube tickets, the 'other things' were the cost of alternative modes of transport. In the demand for football tickets, one of the 'other things' that is important is whether or not the game is being shown on television. If it is, the quantity of tickets demanded at each and every price will be lower than if the game is not televised. To understand how a market works, we must first explain why demand and supply are what they are. (Is the game on television? Has the ground capacity been extended by building a new stand?) Then we must examine how the price adjusts to balance the quantities supplied and demanded, given the underlying supply and demand schedules relating quantity to price.

Let us think again about the market for chocolate described in Table 1. Other things equal, the lower the price of chocolate, the higher the quantity demanded. Other things equal, the higher the price of chocolate, the higher the quantity supplied. A campaign by dentists warning of the effect of chocolate on tooth decay, or a fall in household incomes, would change the ‘other things’ relevant to the demand for chocolate. Either of these changes would reduce the demand for chocolate, reducing the quantities demanded at each price. Cheaper cocoa beans, or technical advances in packaging chocolate bars, would change the 'other things' relevant to the supply of chocolate bars. They would tend to increase the supply of chocolate bars, increasing the quantity supplied at each possible price.

Exercise 1. Check your understanding