In this chapter you will:

• Learn about the benefits of exchange based on the specialisation of production;

• Learn how the use of money facilitates exchange and specialisation;

• See how markets work in terms of demand and supply functions;

• Be introduced to elasticities of demand and supply;

• Consider the distinction between short- and long-run market adjustments;

• See what determines who – buyers or sellers – pays most of the tax on a commodity;

• Learn about financial markets and how the rate of interest is determined.

Markets are the dominant form of economic organisation in modern societies. The main purpose of this chapter is to use demand and supply analysis to explain how markets work. It will also use that analysis to explain how the interest rate is determined, and how it influences the level of saving and investment. Before getting to those matters, we begin by discussing the benefits that can flow from exchange and specialisation, which are what markets are really all about.

EXCHANGE AND SPECIALISATION

Markets are social institutions which facilitate the process by which potential gains from exchange and specialisation are realised. In this section we consider the nature of the gains that markets can realise. First, we look at the gains that can exist on the basis of the fact that where people have different tastes exchanging things may make people feel better off. Second, we shall show that in a world where productive capabilities differ specialisation can make everybody better off.