1.2 How markets work (1.2.9-1.2.10) Flashcards
What is price?
the exchange value for a good or service
What is the Price Mechanism?
The way price responds to changes in demand and supply for a product so that a new equilibrium point is reached in the market
What are the 3 functions of price mechanism?
- Rationing
- Incentive
- Signalling
What does the price mechanism show?
how demand and supply interact
What is the rationing function?
resources are scarce. The price of a good rations that good. This limits supply to those who are willing and able to pay for it
What is the incentive function?
Rising prices act as an incentive to producers as it encourages firms to expand their level of output because of higher profits
What is the signalling function?
if the price of a good changes, this signals to the consumer or producer that they should change their level of consumption or production
What are 2 advantages of the price mechanism?
- no labour or time cost
- consumers have control over what producers make
What are 2 disadvantages of the price mechanism?
- there will be missing markets for some goods e.g. street lamps
- some goods objectively shouldn’t be produced through the price mechanism e.g. being able to buy an organ
What is consumer surplus?
The difference between what a consumer is willing to pay and what they actually pay for a good/service
What is producer surplus?
The difference between what a firm is willing to accept and what they actually receive for a good/service
What is the total surplus?
the sum of the producer and consumer surplus, and is the total benefit to society of economic agents buying and selling a particular good or service
