1.2.6 + 1.2.7 - Price Determination & Price Mechanism

Question 1

What Is Meant By ‘Free Market’?
(2 Points)

Answer 1

~ Any place where buyers meet suppliers to exchange goods and services, free from government intervention.

~ Another name could be the price mechanism.

Question 2

How Are Prices Determined In A Free Market Economy?

Answer 2

By the interaction of demand and supply in a market.

Question 3

Where Does Equilibrium In A Market Occur?
(3 Points)

Answer 3

~ Where D = S.

~ Also known as market clearing position, as there is no excess supply or demand.

~ Represent allocative efficiency.

Question 4

When Does Disequilibrium In A Market Occur?

Answer 4

When demand does not equal supply.

Question 5

What Are The Special Forces Of The Free Market?
(2 Points)

Answer 5

~ When there is disequilibrium the price mechanism always return the market back to equilibrium.

~ ARSI.

Question 6

What Is Meant By ‘ARSI’ Of The Price Mechanism?
(4 Points)

Answer 6

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.

Question 7

What Are Examples Of Disequilibrium?
(2 Points)

Answer 7

~ Excess demand.

~ Excess supply.

Question 8

Describe Excess Demand
(4 Points)

Answer 8

~ 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.

Question 9

Describe Excess Demands Price Mechanism
(4 Points)

Answer 9

~ 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 demand).

~ Higher prices RATION scarce resources by discouraging consumption. (Contraction in demand).

~ Allocate efficiency at equilibrium.

Question 10

Describe Excess Supply
(4 Points)

Answer 10

~ 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.

Question 11

Describe Excess Supply Price Mechanism
(4 Points)

Answer 11

~ 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.