3.1 How markets work

Students will look at economic foundations such as the nature and purpose of economic activity, the factors of production and the importance of making choices. Students will also look at how resources are allocated using a market mechanism.

The central aspect will be an investigation of how prices are determined. This introduces students to concepts such as supply and demand, intermarket relationships and price elasticity.

Students investigate the significance of costs, revenue and profit for producers, leading to an understanding of the concepts of production, productivity and economies of scale. Students will then explore the importance of competition in relation to resource allocation, leading to an investigation of the factors that lead to market failure, with an emphasis on the significance of externalities.

Students should be encouraged to explore the moral, ethical and sustainability issues that underpin economic decision-making and economic activity.

Economic foundations

Students look at the nature and purpose of economic activity based on the production of goods and services and the satisfaction of needs and wants. Students explore the factors of production, leading to an understanding of how and why choices are made. Students will come to an understanding that there is always a cost attached to any economic choice.

Economic activity

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Additional information

  • Needs and wants
  • The central purpose of economic activity
  • The key economic decisions
  • The main economic groups

Students should be able to understand:

  • the difference between a need and a want, and how these can change over time
  • the central purpose of economic activity is the production of goods and services to satisfy needs and wants
  • the key economic decisions are: what to produce, how to produce, and who is to benefit from the goods and services produced
  • consumers, producers and government are the main economic groups
  • the interactions between the main economic groups.

The factors of production

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Additional information

The factors of production

Students should be able to:

  • understand the nature of an economic resource
  • identify and understand examples of the four factors of production (land, labour, capital and enterprise) and the reward accrued to each.

Making choices

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Additional information

  • The basic economic problem
  • Costs and benefits of economic choices, including opportunity costs

Students should be able to understand:

  • how and why choices are made, and how costs and benefits can be weighed up to make a choice
  • the concept of opportunity cost in the context of economic activity.

Resource allocation

Students look at the role of markets in allocating scarce resources. This leads into an exploration of the different economic sectors and concludes with a look at benefits and costs of specialisation, the division of labour and how this naturally leads to exchange.

Markets and allocation of resources

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Additional information

  • Markets
  • Allocation of resources
  • Factor and product markets

Students should be able to understand:

  • a market is an opportunity for buyers and sellers to interact in order to establish price
  • the role of markets in allocating scarce resources
  • the difference between factor and product markets.

Economic sectors

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  • Primary, secondary and tertiary sectors
  • Goods and services

Students should be able to understand:

  • the meaning of primary, secondary and tertiary sectors and their relative sizes in the UK
  • the difference between a good and a service.

Specialisation, division of labour, and exchange

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Additional information

  • The benefits of specialisation and division of labour and exchange
  • The costs of specialisation and division of labour and exchange

Students should be able to understand:

  • the meaning of specialisation and the division of labour
  • how and why individuals and producers specialise
  • the costs and benefits associated with the division of labour, both to the worker and the firm.

How prices are determined

Students explore how prices are determined in a market using supply and demand. They look at intermarket relationships to understand the impact that changes in supply and demand in one market can have on other markets. The section concludes with an investigation of price elasticities, including how they are calculated and interpreted.

Demand for goods and services

Content

Additional information

  • The factors which determine the demand for a good or service
  • Causes of changes in demand
  • The demand curve

Students should be able to understand:

  • what is meant by the demand for a good or service
  • the factors which influence demand
  • how to construct an individual demand curve from consumer data
  • the difference between shifts of, and movements along, the demand curve.

Supply for goods and services

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Additional information

  • The factors which determine the supply of a good or service
  • Causes of changes in supply
  • The supply curve

Students should be able to understand:

  • what is meant by the supply of a good or service
  • the factors which influence supply
  • how to construct an individual firm's supply curve from production data
  • the difference between shifts of, and movements along, the supply curve.

Equilibrium price

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Additional information

  • How equilibrium price is determined by supply and demand
  • How markets supply and demand diagrams can illustrate a producer's revenue

Students should be able to understand:

  • how the interaction between supply and demand determines equilibrium price using a supply and demand diagram
  • why excess demand and excess supply can lead to changes in price
  • how to use supply and demand diagrams to understand the impact of changes in equilibrium market prices
  • how demand and supply curves can be applied to a variety of real-world markets
  • how to demonstrate revenue on a demand and supply diagram.

Intermarket relationships

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  • Complements and substitutes
  • How changes in a particular market are likely to affect other markets

Students should be able to understand:

  • the meaning of complementary and substitute goods
  • the impact of changes in demand, supply and price in one market on other related markets.

Price elasticity of demand

Content

Additional information

  • Price elasticity of demand
  • Factors affecting price elasticity of demand
  • Measuring price elasticity of demand

Students should be able to understand:

  • that changes in price don't always cause equivalent changes in demand
  • the factors that affect price elasticity of demand
  • the difference between price elastic demand and price inelastic demand
  • that price elasticity of demand is measured as the percentage change in quantity demanded, divided by the percentage change in price and be able to perform calculations from given data
  • the implications of price elasticity of demand for producers and consumers.

Price elasticity of supply

Content

Additional information

  • Price elasticity of supply
  • Factors affecting price elasticity of supply
  • Measuring price elasticity of supply

Students should be able to understand:

  • that changes in price don’t always cause equivalent changes in supply
  • the factors that affect price elasticity of supply
  • the difference between price elastic supply and price inelastic supply
  • that price elasticity of supply is measured as the percentage change in quantity supplied, divided by the percentage change in price and be able to perform calculations from given data
  • the implications of price elasticity of supply for producers and consumers.

Production, costs, revenue and profit

Students explore the significance of cost, revenue and profit for producers, leading to an understanding of the significance of productivity on increasing profits. Students explore the concept of economies of scale and the benefits these can bring.

The importance of cost, revenue and profit for producers

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Additional information

  • Business objectives
  • Types of costs
  • Types of revenue
  • Profit
  • The importance of cost, revenue and profit for producers
  • Moral and ethical considerations

Students should be able to understand:

  • business objectives, including profit, sales growth and increasing market share
  • how to identify and calculate Total and Average, Fixed and Variable costs
  • how to identify and calculate Total and Average Revenues
  • that total revenue – total costs = profit, and that a firm may aim to increase its profits by reducing average costs and/or increasing revenues
  • that higher prices imply higher profits and that this will provide the incentive for producers to expand production
  • that the motivations of producers may conflict with ethical and moral interests.

Production and productivity

Content

Additional information

  • The meaning and importance of productivity
  • The factors that influence productivity

Students should be able to understand:

  • the difference between production and productivity
  • the benefits of increased productivity.

Economies of scale

Content

Additional information

  • The meaning of economies of scale
  • Types of economies of scale
  • Diseconomies of scale

Students should be able to understand:

  • economies of scale as the effect on average costs of a rise in production
  • the implications and effects of economies of scale on business behaviour
  • the costs and benefits of growth for a business
  • the different types of economy of scale, including managerial, purchasing, financial, technical and risk-bearing
  • what is meant by diseconomies of scale.

Competitive and concentrated markets

Students come to an understanding that there are different types of market structures and explore competitive and non-competitive markets. Finally, students will look at the operation of the labour market and factors that determine wages.

The importance of market structures on producers and consumers

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Identifying market structures

Students should be able to understand:

  • that there is a range of market structures
  • factors such as the number of producers, the degree of product differentiation and ease of entry as being used to distinguish between different market structures.

Competitive markets

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Additional information

  • The main characteristics of a competitive market
  • The impact of competitive markets on price and choice
  • The economic impact of competition on producers and consumers

Students should be able to understand:

  • what is meant by a competitive market
  • how producers operate in a competitive market
  • the economic impact of competition on consumers, producers and workers
  • why profits are likely to be lower in a competitive market than one that is dominated by a small number of producers.

Non-competitive markets

Content

Additional information

  • The main characteristics of a non-competitive market
  • The impact of non-competitive markets on price and choice
  • Monopoly and oligopoly

Students should be able to understand:

  • what is meant by a non-competitive market
  • how producers operate in a non-competitive market
  • the meaning of monopoly
  • the meaning of oligopoly
  • the causes and consequences of monopolistic and oligopolistic power.

The labour market

Content

Additional information

  • The role and operation of the labour market
  • Determination of wages through supply and demand
  • Gross and net pay

Students should be able to understand:

  • wage determination using simple demand and supply analysis
  • wage differentials within and between occupations
  • the difference between gross and net pay
  • how to calculate income including gross and net pay.

Market failure

Students explore the meaning of market failure and gain an understanding that the market mechanism does not always allocate resources efficiently. Students will explore the costs associated with misallocation of resources, and how government intervention can counter this.

Misallocation of resources

Content

Additional information

  • The meaning of market failure as misallocation of resources
  • Implications of misallocation of resources
  • Government intervention

Students should be able to understand:

  • market failure as the inability of the market system to allocate resources efficiently
  • the costs associated with misallocation of resources
  • methods of government intervention to counter misallocation of resources.

Externalities

Content

Additional information

  • Defining externalities
  • The difference between positive and negative externalities

Students should be able to understand:

  • externalities as the difference between social costs/benefits and private costs/benefits
  • the difference between positive and negative externalities and identify them
  • that production and consumption can lead to negative externalities.