Lesson 3: Open Markets

Introduction

In this lesson students reflect on their experience in the “In the Chips” activity and connect it to their real-world interactions in markets to better understand the role competition and prices play in guiding market outcomes. Fun video clips and a mini-activity where-in students play an additional round of “In the Chips” help them discover the how open competitive markets can promote economic growth.

Objectives

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

• Use supply and demand models to illustrate changes in real-world market conditions.
• Contrast how buyers and sellers are motivated by price.
• Explain how competition regulates market outcomes.
• Identify the conditions necessary for markets to function.
• Describe the relationship between open markets and economic growth.

Economic Concepts

Demand	Supply	Market Clearing Price
Competition	Substitutes	Price Ceilings
Property Rights	Equilibrium Price	Market Power

Key Ideas

1.Review:

• Institutions are the formal and informal rules of the game that shape incentives and outline expected and acceptable forms of behavior in social interaction.
• Incentives are the rewards and punishments that shape people’s choices.

ERP-3: People respond to incentives in predictable ways.
Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives change, behavior changes in predictable ways.

ERP-4: Institutions are the “rules of the game” that influence choices.
Laws, customs, moral principles, superstitions, and cultural values influence people’s choices. These basic institutions controlling behavior set out and establish the incentive structure and the basic design of the economic system.

2. Open markets are a key institution for fostering economic growth and improving standards of living.

• Price allocation (rationing) in markets creates incentives that address the problem of scarcity better than other forms of rationing.
  • Prices communicate, at extremely low cost, the information about the opportunity costs of exchange which buyers and sellers need to make decisions in the market.
  • In open markets, prices allocate goods and services without buyers and sellers needing additional knowledge about one another.
• The entry and exit of competitors in open markets helps to direct resources to their most highly-valued uses.
  • Prices provide the information and incentives that move competitors into and out of markets.

3. Competition regulates market activity with profits acting as a motivator for sellers.

• Sellers compete with other sellers for profits and buyers compete with other buyers for goods in markets.
• Buyers and sellers do not compete with each other. Their interactions are largely cooperative.

4. Economists conceptually organize the apparent chaos of markets by using the supply and demand model.

• Review: Law of demand and law of supply introduced in Lesson 2.
• Demand – people’s willingness and ability to buy – is affected by such factors as tastes, incomes, and the price and availability of substitutes and complements.
• Supply – producers’ and sellers’ willingness and ability to offer products for sale – is affected by such factors as availability of resources and production cost; the number of sellers; and the prices of other products.
• Prices coordinate market activity by providing incentives to buyers and sellers to act so that both gain from trade.

5. Equilibrium (market clearing) prices emerge from the interactions of demanders and suppliers in markets and provide incentives that shape buyers’ and sellers’ future choices.

• If sellers offer more than buyers are willing to purchase at the current price, inventories accumulate and the market receives a signal that price is too high.
• If buyers cannot purchase all that they demand or cannot find certain goods at the current price, the market receives a signal that price is too low.
• The inventory and purchase signals move price in the direction of an equilibrium price, or market clearing price, where quantity demanded equals quantity supplied.

6. Markets function most effectively when prices move freely in response to changes in supply and demand. Institutional support for markets, in the form of clearly defined property rights and the rule of law, facilitate the free movement of prices.

7. Market power results from successful efforts to reduce competition.

• (Option: Re-run the “In the Chips” activity with limited seller competition.)
• Economic growth is restricted when competition is reduced in a market.

Ideas To Take Away From This Lesson

• Open markets benefit both buyers and sellers by providing a low cost mechanism in which they can trade with each other.
• Open markets encourage economic growth.
• Open entry and exit and competition between participants are necessary for markets to function effectively.
• Clearly defined property rights and a stable rule of law are necessary for markets to function at low cost to participants.