1.2.6 + 1.2.7 + 1.2.8

Question 1

Equilibrium means

Answer 1

State of equality or balance between market demand supply

• no excess demand or supply

Represents a trade off for buyers and sellers - market clearing price

Question 2

Demand increases means what movement in equilibrium price and quantity

Answer 2

Higher price

Higher quantity

Question 3

Demand decreases means what movement in equilibrium price and quantity

Answer 3

Lower price

Lower quantity

Question 4

Supply increases means what movement in equilibrium price and quantity

Answer 4

Lower price

Higher quantity

Question 5

Supply decreases means what movement in equilibrium price and quantity

Answer 5

Higher price

Lower quantity

Question 6

Inward shift of market supply =

Answer 6

Leads to a rise in equilibrium price and a contraction of market demand

Question 7

Outward shift of market demand =

Answer 7

Leads to a rise in equilibrium price and expansion of market supply

Question 8

Moving from one market equilibrium to another

Answer 8

• Changes in equilibrium prices and quantities do not happen instantly.
shifts in supply and demand outlined in diagrams before are reflective of changes in conditions in market.
• So, outward shift of demand initially leads to a shortage at the existing market price (i.e. there will be excess demand).
• This then leads to a short-term rise in price and a fall in available stocks. This acts as a signal to suppliers.
• higher price is then an incentive for suppliers to expand supply, causing a movement along the supply curve towards a new equilibrium point

Question 9

Disequilibrium – excess demand

Answer 9

• Excess demand occurs when quantity demanded exceeds available supply
  • Excess demand happens when current market price is below the equilibrium price.
• result in queuing and upward pressure on price.
  • Higher prices ration demand to those consumers with effective demand.
  • Higher prices – in theory – stimulate an expansion of supply as producers respond to higher profits
• little triangle under equilibrium point represents excess

Question 10

Disequilibrium – excess supply

Answer 10

• Excess supply is a state of disequilibrium in a market.
  • When supply is greater than demand and there are unsold goods in the market, there is excess supply.
  • Surpluses put downward pressure on the market price.
  • As prices fall, there is an extension of demand which cuts the surplus and takes a market towards equilibrium
• little triangle on top of equilibrium point

Question 11

What is the price mechanism?

Answer 11

• Changes in market price act as a signal about how scarce resources should be allocated.
• A rise in price encourages producers to switch into making that good but encourages consumers to use an alternative substitute product
  (therefore rationing the product).
• A fall in price leads to an extension of demand but makes it less profitable for a
  business to supply the good or service affected.

Question 12

Adams smith invisible hand theory

Answer 12

• Adam Smith described the invisible hand of the price mechanism in which the hidden hand of the market operating through the pursuit of self-interest allocated resources in society’s best interest.
• buyers want what’s best for them - quality + cheap
• producers want profit

Question 13

3 main functions of the price mechanism:

Answer 13

Signalling function
Incentives function
Rationing function

Question 14

What is the signalling function?

Answer 14

• when a changing price in a market sends important information to both producers and consumers
• Prices rise and fall to reflect scarcities and surpluses.
• If prices are rising because of high demand from consumers, this is a signal to suppliers to expand production to meet the higher demand.
• If there is excess supply in a market, the price mechanism will help to eliminate a surplus of a good by allowing the market price to fall

Question 15

What is the Incentives function?

Answer 15

• Through choices consumers send information to producers about their changing nature of needs and wants.

• Higher prices act as an incentive to raise output because suppliers stand to make a better profit.
• When demand is weaker in a recession, supply contracts as producers cut back on output.

Question 16

What is the rationing function?

Answer 16

• prices ration scarce resources when demand exceeds supply

- when there is a shortage, price is bid up - leaving only those with willingness and ability to buy

Question 17

Why do incentives matter?

Answer 17

For competitive markets to work efficiently, all agents (consumers and producers) must respond to appropriate price signals in the market.

• could result in market failure when signalling and incentive functions fail to operate

Question 18

Secondary markets occur when…

Answer 18

buyers and sellers are prepared to use an alternative market to re-sell items that have already been purchased.

Eg. Tickets

Question 19

Government intervention in the market mechanism

Answer 19

• the incentives they consumers and producers have are changed by government intervention
• eg, change in relative prices brought about by subsidies and indirect taxation
• gov might impose min/max prices

Question 20

Law of unintended consequences

Answer 20

Encapsulates idea that government intervention can often be misguided and lead to extra problems in society

Question 21

Consumer surplus

Answer 21

Consumer surplus - difference between price consumer is willing to pay and price they actually pay, set by price mechanism

Picture and S-D graph,
Equilibrium point at B
Corresponding P1 and Q1 values
A is top left area where demand meets y axis
Consumer surplus is ABP1 (top left triangle under demand curve)

Question 22

Consumer surplus formula

Answer 22

Difference between price willing to pay and total amount they do pay

Difference x quantity bought

Question 23

Consumer surplus relationship price elasticity of demand

Answer 23

1. When demand for a good or service is perfectly price elastic, consumer surplus = 0. This is because the price that people pay always matches what they are willing to pay. (Picture graph with horizontal demand)
2. In contrast, when demand is perfectly price inelastic, consumer surplus is infinite. Demand does not respond to price changes. Whatever the price, quantity demanded remains the same (likely with an absolute necessity)
3. Inelastic = higher consumer surplus likely

Question 24

Producer surplus

Answer 24

difference between the price producers are willing and able to supply a product for and the price they actually receive in the market.

Picture and S-D graph,
Equilibrium point at B
Corresponding P1 and Q1 values
A is top left area where demand meets y axis
P1B0 is producer surplus (bottom left triangle above supply curve

Question 25

Community surplus

Answer 25

sum of consumer and producer surplus at a given price and quantity in a market

Question 26

point of allocative efficiency.

Answer 26

At a free market equilibrium price, the level of consumer and producer surplus is maximised.

Question 27

What happens to consumer surplus and producer surplus when there’s an outward shift of demand?

Answer 27

increase

increase

Question 28

What happens to consumer surplus and producer surplus when there’s a government subsidy to producers?

Answer 28

increase

increase

Question 29

Examples of price mechanism on local, national and global stages

Answer 29

Local - coronavirus -> shift in good prices (rationing as demand went up so prices went up)
National -> housing prices in London (another rationing function as well as signalling and potentially even incentives)
Global -> 1973 OPEC oil embargo (rationing)