Area of Study 1 The Market System and Resource Allocation

Key knowledge
Key economic concepts including relative scarcity, opportunity cost and the efficient allocation of
resources.
Economic factors influencing decision making of households, businesses, government and other relevant
groups.
The law of demand and the demand curve.
Microeconomic demand side factors that influence prices and quantity of goods and services in individual
markets, including disposable income, the price of substitutes and complements, preferences and tastes,
interest rates, population growth and demographic change, and consumer sentiment.
The law of supply and the supply curve.
Microeconomic supply side factors that influence prices and quantity of goods and services in
individual markets, including the prices of the factors of production, technological change,
productivity growth and climatic conditions.
Effects of changes in supply and demand on equilibrium prices and quantity traded.
The role of relative prices in the allocation of resources.
The meaning and significance of price elasticity of supply and demand.
Factors affecting price elasticity of demand, including the degree of necessity, availability of
substitutes and proportion of income.
Factors affecting price elasticity of supply, including spare capacity, production period and
durability of goods.
Market structure including perfect competition, monopolistic competition, oligopoly and
monopoly, and its impact on prices, the efficiency of resource allocation and living standards.
Sources of market failure including market power, public goods, externalities and asymmetric
information.
The reasons for government intervention in the market, including addressing market failure,
redistribution of income and stabilisation of the level of economic activity.

Key Economic Concepts
Relative Scarcity
Relative scarcity is the concept of needs and wants exceeding the availability of goods and services.
E.g. If 1,000 shoes can be produced, and consumers demand 1,200 shoes, they are relatively scarce.

Opportunity Cost
Opportunity cost is the price of forgoing alternatives by adopting a particular course of action.
E.g. If the government budgets $1 million dollars to education this money may have been sourced from
reducing the defense budget by $1 million.

Efficient Allocation of Resources
This refers to the concept of using natural, capital and labour resources in the most efficient manner to maximize
output.

The Law of Demand

The price of the good or service and the level of disposable income of the consumer influence the quantity
demanded.

The Law of demand states:
As the price of a good or service increases, the quantity demanded decreases.
As the price of a good or service decreases, the quantity demanded increases.

Demand Graph
The law of demand can be represented graphically.
The Law of Supply

The law of supply is the quantity of a good or service supplied by producers at a given price.

The Law of supply states:
As the price of a good or service goes up so to does the supply.
As the price of a good or service goes down so to does the supply.

Supply Graph
The law of supply can be represented graphically.





















Market Mechanism
Equilibrium Price
The intersection between the demand and supply curve represents the equilibrium price for that good. This price
represents the quantity demanded by consumers and the quantity supplied by producers.




















Elasticity of Demand and Supply

Elasticity of Demand
Elasticity of demand is when the change in quantity demanded responds to a change in the price.
If a good is elastic then when the price goes up the demand falls rapidly.
o For example if the price of coffee goes up demand is likely to fall rapidly and consumers may
begin demanding more tea as a substitute.
If a good is inelastic then when the price goes up the demand will not fall rapidly.
o For example if the price of petrol rises demand will likely not fall, as there are no substitutes.

Elasticity of Supply
Elasticity of supply is when the change in quantity produced responds to a change in the price.
If a good is elastic then when the price goes up the supply will likely increase.
o For example if the price of chairs goes up manufacturers are likely to reallocate resources to
increase chair production.
If a good is inelastic then when the price goes up the supply will not likely increase.
o For example if the price of bananas goes up producers will not be able to quickly increase
production of bananas and therefore quantity supplied will remain the same.
Market Failure and Government Intervention

Market failure is the situation when the pursuit of self-interest results in resources being allocated in ways that do
not maximize economic welfare for all members of society, and in crease living standards. Government
intervention may therefore be needed in order to resolve these issues.

Examples of Market Failure
Market power when one firm or a few large firms control prices and output in an industry. This results
in a lack of competition and therefore resources potentially being used inefficiently.
o Monopoly When one firm has complete control over an industry.
E.g. Australia Post
o Oligopoly When a few large firms have complete control over an industry.
E.g. Big four banks and Supermarkets.
o Monopolistic Competition - When there are quite a few producers in the industry but not as
many as wanted.
E.g. Internet Service Providers
Public goods Goods or services that are in high demand but even so they will not be produced in a free
market. This is because it would be impossible to exclude those who do not pay.
o E.g. Street lighting.
Externalities A positive or negative consequence placed on a third party as a result of a businesses
production.
o E.g. Air pollution that has an effect on a nearby city.
Asymmetric Information Where an imbalance of information exists between the buyer and seller.
o E.g. A car salesmen may know more about the history of the car than he says.

Examples of Government Intervention
ACCC Established to prevent anti-competitive behavior.
Public goods The government provides public goods such as streetlights and hospitals.
Carbon Tax Implemented to reduce the negative effect production has on the environment.
Legislation Ensure that knowledge is conveyed equally to both parties, such as fast food labeling laws.