1.2.6 + 1.2.7 - Price Determination & Price Mechanism Flashcards
What Is Meant By ‘Free Market’?
(2 Points)
~ Any place where buyers meet suppliers to exchange goods and services, free from government intervention.
~ Another name could be the price mechanism.
How Are Prices Determined In A Free Market Economy?
By the interaction of demand and supply in a market.
Where Does Equilibrium In A Market Occur?
(3 Points)
~ Where D = S.
~ Also known as market clearing position, as there is no excess supply or demand.
~ Represents allocative efficiency.
When Does Disequilibrium In A Market Occur?
When demand does not equal supply.
What Are The Special Forces Of The Free Market?
(2 Points)
~ When there is disequilibrium, the price mechanism always return the market back to equilibrium.
~ ARSI.
What Is Meant By ‘ARSI’ Of The Price Mechanism?
(4 Points)
1) Allocate scarce resources efficiently.
2) Signal the fact that there have been excess demand / supply, and signal the need for more or less resources in the market.
3) Incentivise producers to increase or decrease output to increase profit.
4) Ration scarce resources by encouraging / discouraging consumption.
What Are Examples Of Disequilibrium?
(2 Points)
~ Excess demand.
~ Excess supply.
Describe Excess Demand
(4 Points)
~ Occurs when prices are below equilibrium (P1 -> QD & QS), difference between QS & QD is excess demand.
~ Shortage, it is not allocative efficiency and is a disequilibrium.
~ E.g. Huge queues, waiting lists and competition between buyers.
~ Naturally prices would rise.
Describe Excess Demands Price Mechanism
(4 Points)
~ Higher prices SIGNAL that there is excess demand to producers and consumers, signalling the need for more resources in the market.
~ Higher prices INCENTIVISE firms to increase their output to make more profit. (Expansion in supply).
~ Higher prices RATION scarce resources by discouraging consumption. (Contraction in demand).
~ Allocate efficiency at equilibrium.
Describe Excess Supply
(4 Points)
~ Occurs when prices are above equilibrium (P1 -> QD & QS), difference between QS & QD is excess supply.
~ Surplus in the market, it is not allocative efficiency and is a disequilibrium.
~ E.g. Warehouses full of stock, shelves full of stock and kitchen is full of ingredients.
~ Naturally prices would fall.
Describe Excess Supply Price Mechanism
(4 Points)
~ Lower prices SIGNAL that there has been excess supply to producers and consumers. Signal that there is less need for resources in the market.
~ Lower prices INCENTIVISES firms to decrease their output and liquidate stock to make more profit. (Contraction in demand).
~ Lower prices RATION scarce resources by encouraging consumption. (Extension in demand).
~ Allocative efficiency at equilibrium.
Describe Minimum Prices
(4 Points)
~ A fixed price (Price floor) enacted by the government, usually set above the equilibrium market price.
~ Is to protect producers from price volatility.
~ Is to solve market failure.
~ Creates excess supply (Surplus), burden on producers on the costs to produce at QS.
Describe This Minimum Price Diagram
(8 Points)
~ Price has increased.
~ There has been a contraction in demand, from Q1 -> QD.
~ There has been an extension in supply, from Q1 -> QS.
~ Creating excess supply, between QD -> QS.
~ Cost of intervention buying (IB) the excess supply, QD + QS + B + C.
~ PR with IB, Pmin + C + QS + 0.
~ PR without IB, Pmin + B + QD + 0.
~ DWL, A + B + D.
Describe Maximum Prices
(3 Points)
~ A fixed price (Price ceiling) enacted by the government, usually set below the equlibirum price level.
~ Used to increase affordability of necessity goods and services.
~ Creates excess demand (Shortage), some consumers can access the market.
Describe This Maximum Price Diagram
(6 Points)
~ Price has decreased.
~ There has been an extension in demand, from Q1 -> QD.
~ There has been a contraction in supply, from Q1 -> QS.
~ Creates excess demand, between QD -> QS.
~ PR, Pmax + B + QS + 0.
~ DWL, A + B + D.
