1.2.7 - Price Mechanism

Question 1

Define Price Mechanism

Answer 1

. The Price Mechanism allocates resources between conflicting uses and tries to solve the basic economic problem

. The Price Mechanism function is to make demand and supply meet together at the equilibrium in a free market. It is a benefit as it brings buyers and suppliers together

. It refers to the effect that price has on demand and supply

Question 2

Name the four function of Price Mechanism

Answer 2

. Rationing Function

. Signalling Function

. Incentive

. Allocate function [Not function but last stage]

Question 3

Explain Rationing Function

Answer 3

. Consumer wants are infinite, but resources are finite. This is the basic economic problem

. One function of price in a market is to allocate and ration these scarce resources at the market equilibrium.

. If demand is very high, but supply is scarce (excess demand) then prices will be high. Limited supply with be rationed to only those buyers ABLE AND WILLING to pay a high price

. If supply is high and demand is low (excess supply), then prices will be low. The low price ensure that a high number of goods will be bought as demand will increase.

Question 4

Explain Incentive

Answer 4

. Prices act as an incentive for buyers and sellers

FOR BUYERS:

. Low prices encourage buyers to purchase more goods. This is because the amount of utility (satisfaction ) gained per pound increases relative to other goods

. Higher prices discourage buying because consumer gets fewer goods per pound spent

FOR SELLERS:

.High price encourages suppliers to supply and sell more to the market. It incentives them to shift their capital and other factors of production (e.g. land and labour) into production of this good.

. Firms may have to take on more workers and invest in new capital equipment to achieve this.

. Lower prices discourage production. A fall in price may drive some firms out of the market as it no longer profitable to supply

Question 5

What is the order for Price Mechanism?

Answer 5

1. ) Signal
2. ) Incentive
3. ) Ration
4. ) Allocate

Question 6

Define Signalling Function

Answer 6

. Signalling Function is when changes in price gives information to buyers and sellers, which influence their decisions to buy and sell

For Producers:

. Excess demand can signalled by long queues, waiting lines and buyer competition.

. Excess supply can be signalled by empty queues, large stocks of goods, lack of waiting lines

For Consumers:

. Consumers may receive a signal that prices of goods and services have risen or fallen

. Interest rates may have fallen or decreases

. A fall or rise in share prices send signals to investors

Question 7

Disadvantages / Issue with Price Mechanism

(Evaluation)

Answer 7

1.)The free - market price mechanism DOES NOT ALWAYS ensure an equal distribution resources at the social optimum point leading to market failure. There is income inequality as those with money have buying power, whilst those without are left out. This would be the case if prices increase due to excess demand. The excess demand is RATIONED out, due to consumers that are not willing and able to buy goods

Additionally, suppliers may stop supplying goods and services, if the prices are too low, since their will be a lack of profit. This can increase the income equality and lead to unequal distribution of resources.

2. ) In a free market, there is under - provision of public goods. This may require government intervention.
3. ) There may be negative externalities, information gaps, asymmetric information. This can all lead to market failure

Question 8

In which market does price mechanism work in?

Answer 8

. The Free Market

Question 9

Name three types of Markets

Answer 9

. Local market
. Global Market
. National market

Question 10

Explain Price Mechanism in Local Market

Answer 10

. Covid - 19 pandemic, along with increasing cost of production due to rise in petrol due to HGV driver shortage, has resulted in cost of production for local supermarkets to rise. This meant that supply decreased and there is excess demand.

(* Refer to Price Mechanism Worksheet)

Question 11

Explain Price Mechanism in National Market

Answer 11

. UK has had population increase recently, causing the demand curve for houses to shift to the right. There has been excess demand, due to demand exceeding supply. Supply has not increased for the housing market in the UK, due to increase in cost of production rising (energy bills, raw material price increases, COVID - 19, etc.)

Question 12

Explain Price Mechanism in Global Market

Answer 12

. OPEC restricted the supply of oil due to geopolitical factors. This led to excess demand as demand was higher than supply. Supply shifted to the left. This led to prices rising