2.3 Competitive Market Equilibrium: Signals and Social Surplus Flashcards
Incentive role of prices
Chat definition: Prices provide producers and consumers the incentive to respond to price changes. Higher prices encourage producers to supply more and discourage consumers from purchasing, while lower prices incentivize consumers to buy more and may discourage production. This guides resource allocation in the market, helping achieve equilibrium.
Save my Exams definition: when prices for a good/service rise, it incentivises producers to reallocate resources from a less profitable market to this market in order to maximise their profits. Falling prices incentivise the reallocation of resources to new markets
Rationing
A method used to allocate limited goods, services, or resources among individuals or groups when demand exceeds supply.
Resource allocation
The process of assigning available resources (such as land, labor, and capital) to various uses in order to produce goods and services. In economics, it aims to answer the basic economic questions: What to produce? How to produce? For whom to produce? efficient resource allocation makes sure the resources are used in the best possible way.
Consumer surplus
Refers to the difference
between the highest prices consumers are
willing to pay for a good and the price
actually paid. In a diagram, it is shown
by the area under the demand curve and
above the price paid by consumers.
Producer surplus
Refers to the difference
between the price received by firms for
selling their good and the lowest price
they are willing to accept to produce the
good. In a diagram, it is shown as the area
under the price received by producers and
above the supply curve.
Social/community surplus
The sum of consumer and producer surplus; it is maximum in a competitive market with no market failures.
Welfare loss
Refers to loss of a portion of
social surplus that arises when marginal social benefits are not equal to marginal social costs (MSB≠MSC), due to market failure.
Allocative efficiency
When resources are distributed in a way that maximizes the total benefit to society. This An allocation of resources that results in producing the combination and quantity of goods and services mostly preferred by consumers. It is achieved when no one can be made better off (by consuming more or different goods) without making someone else worse off. In other words, resources are used in the most socially beneficial way. The condition for allocative efficiency is met when P = MC (price equals marginal cost), meaning that the price consumers are willing to pay reflects the cost of producing one more unit.
Allocative inefficiency
Where resources in the economy are not distributed optimally and therefore consumers cannot purchase the quantity of goods that they desire
scarcity
The limited availability of economic resources (factors of production) relative to society’s unlimited wants/needs of goods and services. this tension results in economic choices which create opportunity costs.
opportunity cost
The value of the next best alternative that must be given up or sacrificed in order to obtain something else.
re-allocation
reallocation refers to the process of moving resources from one use to another to create a different distribution of resources across various goods or services. This change aims to achieve a more efficient or desired allocation in the economy, often in response to shifts in demand or other economic factors.
signalling function
The signalling function of price in a market occurs when changes in price provide direct signals to consumers and producers about the relative scarcity/abundance of a good or service.
Higher prices signal to producers to increase production and to consumers that a good is becoming more scarce or expensive, which may lead them to reduce their demand or seek alternatives. Conversely, lower prices signal to producers to decrease production and to consumers that a good is more abundant or affordable, which may encourage them to increase their demand.
This mechanism helps allocate resources efficiently in response to changing supply and demand conditions.
incentive function
The incentive function of price refers to how changes in price serve as signals to motivate producers and consumers to adjust their behaviours.
When the price of a good or service increases, it provides an incentive for producers to increase supply for higher profits, while consumers are incentivised to decrease their demand due to higher costs. Conversely, a price decrease encourages consumers to increase demand and producers to reduce supply due to lower profitability.
This function plays a crucial role in allocating resources efficiently in a market economy.
3 functions of price
1) signalling function
2) incentive function
3) rationing function
