1.2.7 Price mechanism the 4 functions

Question 1

If there is excess demand in the economy, how does price mechanism work?

Answer 1

• When there is excess demand it shifts at the same price since there is excess demand so it will be in dis-equilibrium.
• This will cause signals to be sent that prices are too low so firms will raise the price to satisfy consumer demand and maximize profits
• this is because excess demand gets rationed
• so that there is perfect allocation in the end

Question 2

What happens if there is excess supply, how does price mechanism works?

Answer 2

• when there is excess supply in the market since it will shift at the same price so it will be in disequilibrium.
• this means signals will be sent that prices are too high because excess stock is piled in warehouses.
• this means excess supply gets rationed
• as a result, there will be a perfect allocation

Question 3

what is a evaluation in price mechanism

Answer 3

The invisible hand- the economic concept that describes the unintended greater social benefits and public goods brought by individuals acting in their self interest-e.g a person who buys coffee and bagel to make them feel better off

Question 4

what happens in a free market?

Answer 4

the price mechanism allocates resources

Question 5

how does price mechanism work?

Answer 5

they are determined by supply and demand.
-prices will rise when buyers want to purchase more than suppliers want to sell, this encourages suppliers and they will sell more- higher profit

Question 6

define rationing function?

Answer 6

price systems is a way of rationing goods when price rise, some may not be able to afford to buy the product and others may not have the derive.

Question 7

how does the signalling function work?

Answer 7

when prices rise, producers move resources into the manufacture of the product.
-when there is a change of price it indicates to suppliers and consumers that market conditions have changed so they should change the quantity bought and sold-price equilibrium moves.

Question 8

how does the incentive function work?

Answer 8

this acts as an incentive for people to work hard.

• buyers realise that if they have more money then they will able to buy more products
• suppliers realise if that they want to produce more goods they will make more money
• low prices act as an incentive for consumers to buy more of a good and high prices act as an incentive to suppliers to sell more of a good.

Question 9

explain local?

Answer 9

covid-19 has disrupted supply chains and many countries stopped importing to prevent the virus.

• e.g Local British groceries since they stopped importing there were fewer goods on the shelves. since demand for food is high but supply is low.
• prices of food rises which will ration excess demand and since it’s a necessity consumers will have to buy it regardless