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UNIT 2 – ECONOMIC FORCES AT WORK
BASIC ECONOMIC CONCEPTS
MARKET
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Market is the place where sellers and buyers meet and trade with their goods and services.
SUPPLY AND DEMAND
 Supply:
- It refers to the quantity of a product that a firm or industry is willing to produce at a specified price. As
the selling price increases, firms will produce more of the product because higher prices mean greater
profits.
- It is influenced by several things, such as the product price, the availability and price of resources, the
price of technology and costs of innovation, wage levels, the price of related products – mainly
substitutes (alternative items that can replace a particular item because they serve the same purpose, e.g.
two brands of the same commodity) and complements (products that are often used together, e.g. video
cassettes and video recorders) – , the number of suppliers, inflation expectations, and government
regulations (e.g. taxes, subsidies etc).
- supply curve: shows the direct proportionality between price and quantity.
 Demand:
- It refers to the quantity of a product that buyers are willing to buy at a specified price. As the selling
price increases, people will buy less of the product because higher prices take more of their income.
- It is influenced by the price of the product or service, alternative items and related goods.
- demand curve: shows the inverse relationship between price and quantity.
 Market equilibrium is achieved when the economic forces are balanced, i.e. the total demand is satisfied
by the total supply. It means that all suppliers are able to sell their goods at the equilibrium price. If
demand exceeds supply, there is shortage. Conversely, if there is greater supply, there is surplus. A
competitive market tends towards market equilibrium.
ECONOMIC COMPETITION
 Economic competition is a key notion in a market economy and refers to the situation in which
businesses try to outdo their rivals by offering lower prices and or better service, etc to make more profit.
Free competition exists when price movements are only influenced by the forces of supply and demand
and there are no government interferences.
 In the case of perfect or pure competition there is a high number of producers, each with a small market
share. None of them can influence prices on their own and new companies can enter the market without
considerable difficulties. Goods are homogenous and substitutable, sellers and buyers have all
information about market conditions. Probably the agricultural market is the closest example of perfect
competition. Imperfect competition is when there is neither perfect competition nor pure monopoly.
 Pure monopoly is a market situation where there is only one provider of a product or service without
competition of near substitutes and therefore can control market prices to maximise profits. Monopolies
can be national, regional or local. There are severe barriers for new businesses to enter the market. The
term monopoly is also used for companies that have competition but have the largest market share. A
monopoly price is usually higher than it would be under competitive conditions. Monopolists can set the
price and even the quantity of goods they sell. However, governments usually have legislation against
monopolies to protect consumers’ interests.
 Oligopoly is a market situation where a few suppliers dominate the sale of a commodity or similar
brands. These companies are interdependent, which means they are likely to respond to their
competitors’ strategic moves when it comes to advertising, pricing or investment. There are barriers to
entry into the market. Participants may collude and form a cartel, though in most countries such
agreements are strictly regulated. Telecommunications companies or supermarkets are examples of this
form.
THE GOVERNMENT’S ROLE IN THE ECONOMY
 As a major role, governments influence the creation, accumulation and redistribution of wealth
generated in a given economy. To stimulate economic activity governments may use fiscal/budgetary
and monetary policies.
 Keynesianism is a school of economic thought named after John Maynard Keynes. It believes in fiscal
policy which means government measures concerning taxation, public expenditure, and so on.
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 Monetarism is a school of economic thought named after Milton Friedman, the most famous monetarist
economist. It is considered to be a criticism of Keynesianism. Monetarists believe in central bank
measures concerning the rate of growth of the money supply (the amount of money in circulation) and
argue the necessity of government intervention in the economy.
 Black economy means economic activities that are illegal like smuggling. The goods traded in black
markets are usually scarce because they are forbidden or their quantity is officially controlled by the
government.
 In a welfare state the government provides services and allocates benefits, allowances and income
supplements to people in need.
 In a free market economy the allocation of resources, as well as the economic choices of individuals and
businesses are only determined by the economic forces (i.e. supply and demand). A market economy is
based on private ownership (i.e. people are free to possess factors of production and decide what to
produce, sell, or buy), and profit is the major motivating force for entrepreneurs.
 In a centrally planned economy it is the government who co-ordinates production and distribution. As
instead of economic forces the government determines economic output, there can be a mismatch
between supply and actual demand.
 Pure market economies or planned economies are rare. Today most countries have mixed economies
where the government participates in economic decision-making and provides welfare services.
 Privatisation is the sale or transfer of companies, services or assets from the public to the private sector.
Some of its advantages might be higher revenues to the country and the introduction of new
technologies, and it may strengthen competition and the quality of services.
THE BUSINESS /TRADE CYCLE (MAIN POINTS):
Economic activity is not usually stable over a long period of time but repeatedly shifts from prosperity to
recession. Its main points are the following:
- peak: the economy is booming
- recession: at least 6 consecutive months of sluggish economic activity (negative growth of real GDP)
- trough : the low point of the business cycle
- expansion: the economy begins to recover (lasts for at least 3 consecutive months)
Governments try to alleviate the extremes of inflation and depression by stimulating the economy in slack
times and restraining during expansion.
MONEY
 What is money?
- We can define it in two ways: - what it looks like; - what it does.
1 / what it looks like (=the forms of money):
a. oxen, shells, beads, salt, silver, gold (barter)
b. coins and banknotes
c. credit cards and cheques (--cashless society)
- Why did gold give way to paper money?
a. the costs of mining and processing gold are relatively high
b. paper money is more convenient to use as:
-gold is too heavy to carry
-gold is too soft to be durable
2 / what it does (=the functions of money)
- It serves as:
a. a medium of exchange (the case of the naked farmer and the tailor)
b. a standard measure of value /unit of account (to express the price /value of things – everything would
have several thousand prices depending on what we compare)
c. a store of value (people like to save part of their earnings for future use. It is a more convenient way than
storing it in land, glassware or whiskey)
 Money Supply:
- It means how much money exists in the economy at a given time.
[The narrow definition of money supply is M1.
-M1= currency (coins and banknotes) + current accounts
-M2 + M3= less liquid substitutes of M1 (deposit accounts and other funds)
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Therefore, M3 means money supply in its broadest meaning. MS= M1+M2+M3]
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It is said that we are heading towards a cashless society with a highly sophisticated system of credit
cards in which a computer network would handle the transfer of money from one account into another at
the moment of transaction. As a result, soon there will be little need to carry cash at all.
INFLATION
 Definition:
- Generally, a low rate of increase in the price level (2-3% per year) is considered as an inevitable
consequence of an expanding economy.
- Problems arise when the purchasing power of a currency starts to decline steadily and dramatically. This
is called inflation.
 Types of inflation:
1, moderate /creeping inflation
2, galloping inflation
3, hyperinflation
 Causes of inflation:
1, There are two theories about the possible causes of inflation:
a. the theory of demand-pull inflation:
- the rise in the price level is caused by increases in consumer demand, especially when the government tries
to stimulate the economy by easing credits and to maintain full employment.
b. the theory of cost-push inflation:
- it is the business world that increases the prices of goods and services even though there is no excess
demand for them.
2, budget deficit:
- when it is financed by long-run money-growth, e.g. by printing more money
3, external shocks:
- e.g. an increase in the price of basic sources of energy (e.g. oil) possibly increases all prices.
4, people’s expectations:
- when people believe that prices will rise, they are bound to rise.
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Inflation works like a vicious circle: wages and prices keep rising in an inflationary spiral, often
resulting in runaway /uncontrolled inflation.
 Effects of inflation:
1, it may lower the living standards:
- incomes lag behind prices.
2, it may discourage savings:
- their real value falls through time, which will cause fewer investment. This slows down the growht of the
economy.
3, it may cause exports to fall and imports to rise:
- this may lead to balance of payments deficits.
4, moderate /creeping inflation may accelerate and become galloping inflation:
-this may cause the breakdown of the monetary system.
 How to cure inflation:
1, by introducing monetary restrictions:
- aim: to reduce spending, and increase savings and investments by raising interest rates.
2, by applying means of fiscal policy:
- aim: to drive inflation down by increasing taxes.
3, by permitting more unemployment
4, by government investments
 Hyperinflation records:
- 1922-23: the German mark; 1946: the Hungarian pengő (1946: the issue of the Hungarian Forint)
 Deflation is the opposite of inflation, i.e. the general price level decreases.
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