In this chapter we explore the working of markets in more detail. We start by examining one of the most important concepts in the whole of economics – that of elasticity (Sections 2.1–2.4).
A bumper harvest may seem like good news for farmers: after all, they will be able to sell more. But is it good news? Although they will sell more, the effect of the increased supply will be to drive down the price – and that’s bad news for farmers! So will the increased sales (the good news) be enough to compensate for the reduction in price (the bad news)? Will farmers end up earning more or less from their bumper harvest? It all depends on just how much the price falls, and this depends on the price elasticity of demand for their produce. This is a measure of how responsive demand is to a change in price.
It is not just the responsiveness of demand that is important in determining the functioning of markets. It is also the responsiveness of supply. Why, do you think, do some firms respond to a rise in price by producing a lot more, whereas others only produce a little more? Is it simply because of different technologies? We will discover just what influences the price elasticity of supply in Section 2.3.
The chapter closes by looking at what happens if governments set about controlling prices. Why will shortages occur if the government sets the price too low, or surpluses if it sets it too high? When might governments feel that it is a good idea to fix prices?
