Economic analysis is useful because of the importance of economic issues in the business environment. Anyone who has lived through the 2008-9 world recession can scarcely doubt how much we are all affected by these issues. Economic theories often use simplifying assumptions. Two of the most common assumptions are (a) that producers and consumers make rational decisions and (b) that we can change on factor whilst leaving everything else constant.
Rational behaviour implies that consumers consistently try to maximize their utility or satisfaction when buying goods and services. The second assumption allows us to ignore complex interactions between different factors and study one thing at a time. Both these assumptions are convenient as they make things simpler, but the real world is often more complicated. This means that economic analysis does not provide us with a full picture.
Economics is broadly divided into two main branches: microeconomics, which studies markets and resource allocation and macroeconomics, which study the interaction between economic growth, employment, inflation and the balance of payments at the national level.
1.8 The market mechanism
Supply and demand analysis
Resources are allocated in response to price movements which bring demand into line with the supply; this is known as the market mechanism. Demand indicates consumers’ willingness and ability to buy a product at a range of different prices. Supply indicates suppliers’ willingness and ability to produce a product at a range of different prices. Whilst consumers generally prefer lower prices, suppliers are attracted by higher prices, so in this sense they represent opposing market forces.
The market normally moves towards equilibrium, where demand and supply are equal, where the two curves intersect. * If supply exceeds demand at a particular price, there is a surplus and the price will fall to bring supply...