1.2.6, 1.2.7 Price determination and price mechanism Flashcards
When does market equilibrium occur?
When demand = supply to form an equilibrium price (Pe) and quantity (Qe) (market clearing position)
What is the market clearing position?
When the market is clear of excess supply or excess demand
Define surplus
When there is excess supply in a market
Define shortage
When there is excess demand in a market
What are the functions of the price mechanism (market forces)?
1) Allocate scarce resources efficiently
2) Ration scarce resources by encouraging/discouraging consumption
3) Signal surpluses/shortages and the need for more or less resources
4) Incentivise producers to increase or decrease output in order to gain more profit
When is there a shortage in the market?
Qd > Qs:
When the price of a good is below the equilibrium price, meaning that the QD for the good exceeds the QS, as firms are only willing to supply so much at the given price
When is there a surplus in the market?
Qs > Qd:
When the price of a good is above the equilibrium price, meaning that the QS of the good exceeds the QD, as consumers are not willing to consume the amount which is supplied due to the higher price
How are market forces used to eliminate excess demand?
1) Signals to producers that there is excess demand and need for more resources in the market (prices too low - upwards pressure)
2) Incentivises firms to inc. output: to gain more profit (extension in supply)
3) Resources/demand rationed by discouraging consumption: inc. in price (contraction in demand)
4) Resources have been reallocated, at a (new) equilibrium
How are market forces used to eliminate excess supply?
1) Signals to producers that there is excess supply and the need for less resources in the market (prices too high - downwards pressure)
2) Incentivises firms to dec. production: to sell/liquidate excess supply, make more profit and produce less (contraction in supply)
3) Resources/demand rationed by encouraging consumption (contraction in demand)
4) Resources have been reallocated, at a (new) equilibrium
What did Adam Smith mean by the “invisible hand”?
The interaction between consumers and producers (market forces) will sort out any changes in the market, without any government intervention
How is excess supply seen in the real world?
- excess stock in storage/warehouses
- stock on shelves
Prices fall naturally as they need to be in order to sell off excess stocks
How is excess demand seen in the real world?
- long queues
- competition between buyers
- waitlists
Prices rise naturally when firms realise they are not able to satisfy/supply the demand
