1.2.7 The Price Mechanism

Question 1

what is the price mechanism

Answer 1

• a fundamental concept in economics that uses the forces of supply and demand to allocate resources and determine prices in a market economy
• it relies of the interaction between buyers and sellers to determine the equilibrium price and quantity of goods and services

Question 2

what are the functions of the price mechanism

Answer 2

• rationing
• signalling
• incentives

Question 3

explain rationing as a function of the price mechanism

Answer 3

when demand is greater than supply prices will rise so that the good/service is rationed to only those who can afford to buy it therefore allowing demand to meet supply

Question 4

explain signalling as a function of the price mechanism

Answer 4

when the price of a product rises it signals to producers that the demand for that product is probably high and firms should increase production. prices are used to signify where and how resources should be allocated

Question 5

explain incentives as a function of the price mechanism

Answer 5

when a price rises it creates an incentive for firms to shift production towards these products that help generate profits and vice versa

Question 6

what are the different types of market

Answer 6

• local
• national
• global

Question 7

explain price volatility in markets in relation to supply shocks

Answer 7

• an adverse supply shock can cause market prices to rise especially when PED is low.
• if the demand curve is price inelastic when the supply curve shifts, there will be a significant increase in price.
• higher prices rations demand from consumers

Question 8

explain price volatility in markets in relation to demand

Answer 8

• rising market demand can cause price spikes - especially when elasticity is low
• if the supply curve is price inelastic when the demand curve shifts, there will be a significant increase in market price
• this is a signal to producers to expand output and enjoy higher revenues and profits