Examples of markets

Allocation of Resources – The Role of Markets

Lesson Objective

By the end of this lesson students will be able to:

• Define a market using the exact Cambridge IGCSE wording.
• Identify and give examples of all required market types.
• Explain how the price mechanism answers the three basic economic questions.
• Describe market equilibrium, shortages and surpluses and explain how shifts in demand or supply cause price changes.
• State the definitions and formulas for price elasticity of demand (PED) and price elasticity of supply (PES), list their determinants and name the three elasticity categories (perfectly inelastic, unitary elastic, perfectly elastic).
• Explain why elasticity matters for households, firms and government.
• Identify the market‑failure types required by the syllabus and the full range of government interventions.
• Discuss the arguments for and against a mixed economic system, including privatisation and nationalisation.
• Draw and label all required diagrams accurately.

Key Concepts

• Market (Cambridge definition): “A place or arrangement where buyers and sellers interact to exchange goods, services or resources.”
• The price mechanism communicates information about scarcity and consumer preferences through price signals.
• Through these signals markets answer the three basic economic questions:

  • What to produce – determined by consumer demand.
  • How to produce – determined by the cost of factors of production.
  • For whom to produce – determined by individuals’ willingness and ability to pay.

Types of Markets (with examples)

1. Product Markets

Final goods and services purchased by households.

• Retail grocery stores – allocate food resources.
• Automobile dealerships – allocate transport equipment.
• Online streaming services – allocate entertainment content.
• Clothing boutiques – allocate fashion apparel.

2. Factor Markets (the four factors of production)

• Labour market: firms hire workers; wages signal the relative scarcity of skills.
• Land market: rent determines the allocation of agricultural, residential or commercial land.
• Capital market (physical capital): firms obtain machinery, equipment and buildings; interest rates guide investment decisions.
• Enterprise (entrepreneurship) market: individuals offer ideas, risk‑taking and organisational ability; profit potential signals the desirability of new ventures.

3. Financial Markets

Facilitate the flow of money between savers and borrowers.

• Stock market: allocates ownership of companies to investors.
• Bond market: allocates long‑term financing for governments and corporations.
• Foreign‑exchange market: allocates foreign currency for international trade.
• Money market: provides short‑term funding for businesses and the public sector.

Comparison of Market Types

How Markets Allocate Resources

1. Consumers express preferences through their willingness to pay.
2. Prices adjust to reflect the relative scarcity of a good or service.
3. Producers respond to price signals by altering the quantity supplied, the techniques of production, and the mix of goods produced.
4. Resources flow towards the uses that generate the highest profit (for firms) or the greatest utility (for households).
5. If demand rises, the demand curve shifts right; the higher equilibrium price attracts new entrants and encourages existing firms to increase output.
6. If supply exceeds demand, a surplus occurs; the price falls, signalling firms to cut output or exit the market.

Market Equilibrium, Shortage and Surplus

• Equilibrium price (P_e) and quantity (Q_e) – the point where the demand and supply curves intersect; quantity demanded equals quantity supplied.
• Shortage: price set below P_e → quantity demanded > quantity supplied → upward pressure on price.
• Surplus: price set above P_e → quantity supplied > quantity demanded → downward pressure on price.

Diagram guidance: draw a standard demand‑supply graph, label P_e and Q_e, then illustrate a price ceiling (shortage) and a price floor (surplus).

Price Changes – Shifts in Demand and Supply

According to the syllabus, price movements are caused by shifts of the curves, not by movements along a static curve.

• Demand‑side factors (shift right/left): changes in consumer income, tastes, population, expectations, and prices of related goods (substitutes & complements).
• Supply‑side factors (shift right/left): changes in technology, input prices, taxes/subsidies, expectations of future prices, and the number of sellers.

A shift in either curve creates a new equilibrium price and quantity.

Price Elasticity of Demand (PED) & Price Elasticity of Supply (PES)

Elasticity Categories (required terminology)

• Perfectly inelastic: PED = 0 (vertical demand curve).
• Inelastic: 0 < PED < 1 (steep curve).
• Unitary elastic: PED = 1 (45° curve).
• Elastic: PED > 1 (flat curve).
• Perfectly elastic: PED = ∞ (horizontal demand curve).
• The same categories apply to supply (PES) with analogous curve shapes.

Determinants of PED

• Availability of close substitutes – more substitutes → higher elasticity.
• Proportion of income spent on the good – larger share → higher elasticity.
• Definition of the market – narrowly defined markets are more elastic.
• Time horizon – demand becomes more elastic over the long run.

Determinants of PES

• Flexibility of production techniques – more flexibility → higher elasticity.
• Time period – supply is more elastic in the long run.
• Availability of inputs – abundant inputs → higher elasticity.

Why Elasticity Matters

• Households: determines how a price change affects total expenditure.
• Firms: influences total revenue and guides pricing, output and production‑method decisions.
• Government: helps predict the impact of taxes, subsidies and price controls on revenue, consumption and welfare.

Market Failure (syllabus‑required types)

A market failure occurs when the free market does not allocate resources efficiently.

• Public goods: non‑rival and non‑excludable (e.g., street lighting, national defence).
• Merit goods: goods that generate positive external benefits and are under‑consumed (e.g., education, vaccination).
• Demerit goods: goods that generate negative external costs and are over‑consumed (e.g., cigarettes, alcohol).
• Externalities: costs or benefits that affect third parties (e.g., pollution, immunisation).
• Monopoly power: a single seller can restrict output and raise price above marginal cost.

Government Intervention (tools required by the syllabus)

Mixed Economic System – Arguments For and Against

A mixed economy combines market mechanisms with government intervention.

Arguments for a mixed economy

• Markets allocate most resources efficiently through price signals.
• Government can correct market failures, provide public/merit goods and protect vulnerable groups.
• Flexibility – the economy can adapt to changing circumstances and social goals.
• Privatisation and nationalisation can be used strategically: privatisation to improve efficiency, nationalisation to achieve social objectives.

Arguments against a mixed economy

• Government intervention may create bureaucracy, inefficiency and reduced incentives for firms.
• Risk of political interference and misallocation of resources.
• Excessive regulation can stifle innovation and competition.
• Privatisation may lead to reduced public control over essential services.

Cross‑cutting Issue: Sustainability & the Environment

While not a separate sub‑topic, sustainability considerations often appear in questions about externalities, public goods and government policy. Students should be prepared to discuss how environmental concerns (e.g., carbon taxes, green subsidies) fit within the market‑failure framework.

Diagram Requirements for IGCSE 0455 – 2.1

Students must be able to draw and label the following diagrams accurately:

• Demand‑supply diagram showing equilibrium, shortage (price ceiling) and surplus (price floor).
• Demand‑supply diagram with a right‑hand shift of demand and/or supply and the resulting new equilibrium.
• Elasticity diagrams:

  • PED – steep (inelastic), flat (elastic), perfectly inelastic, perfectly elastic, unitary elastic.
  • PES – steep (inelastic) vs. flat (elastic) supply curves.

• Market‑failure diagram (e.g., external cost curve showing private marginal cost vs. social marginal cost).
• Government‑intervention diagrams:

  • Tax – vertical upward shift of supply (or downward shift of demand) and the resulting price wedge.
  • Subsidy – vertical downward shift of supply (or upward shift of demand) and the resulting price wedge.
  • Price ceiling and price floor – indicate resulting shortage or surplus.

Key Take‑aways

• Markets are places where buyers and sellers interact; they allocate resources through the price mechanism.
• The price mechanism answers the three basic economic questions and moves the economy toward equilibrium.
• Equilibrium, shortages and surpluses are explained by the interaction of demand and supply curves; price changes result from shifts in these curves.
• Elasticities measure responsiveness; the syllabus requires knowledge of the three elasticity categories and their determinants.
• Market failures (public goods, merit/demerit goods, externalities, monopoly) justify government intervention using the tools listed.
• A mixed economy seeks to combine market efficiency with government correction of failures, but it involves trade‑offs such as potential inefficiency and political risk.
• Students should be comfortable drawing and explaining all required diagrams, as they form the core of the IGCSE assessment for this topic.