2.5 - Competitive Markets: Demand and Supply - The role of the price mechanism and market effeciency

Question 1

Price mechanism

Answer 1

Prices determined by the forces of supply and demand in competitive markets

Question 2

What is known as the Invisible hand of the market

Answer 2

The market mechanism working through prices. That is where at equilibrium positions, the buying and selling choices of all buyers and sellers are satisfied and in balance.

Question 3

Signalling and incentive functions of price ex 1 - product market- strawberries

Answer 3

If consumers decide they would like to eat more strawberries because of their health benefits - a change in tastes - demand increases shifting the demand curve right from D1 to D2
At the initial price P1, this results in a shortage - the difference between qs and qd where quantity supplied is less than quantity demanded.
Price of strawberries begins to rise and will continue to rise until shortage has dissappeared.
This happens at P2 and Q3

Question 4

What happened in ex 1?

Answer 4

1. The new higher price signalled or conveyed information to producers that a shortage in the strawberry market had occured.
2. The increase in price is also an incentive for producers to increase the quantity of strawberries supplied - at higher price strawberry production is more profitable. Movement along supply curve ( increase in quantity supplied)

Question 5

How is the increase in price a signal and incentive for consumers?

Answer 5

The increase in price is a signal and incentive for consumers, signalling that strawberries are now more expensive and an incentive to buy fewer strawberries - movement along demand curve. (decrease in quantity demanded)

Question 6

What was the overall impact of the increase in price.

Answer 6

As a result of the increase of price, there was a reallocation of resources
More resources are now allocated to strawberry production.

Question 7

Signalling and incentive functions of price ex 2 - resource market - labour market.
What would happen to supply and supply curve of labour as a result of immigration

Answer 7

Increase in the supply of labour so there is a shift labour supply curve leftwards

Question 8

What is created at the old wage, W1

Answer 8

There is a surplus of labour shown in the difference between q2 and q1 of labour.

Question 9

What does the surplus cause to happen?

Answer 9

The surplus causes the wage to start falling and this falls until the surplus has disappeared.

Question 10

How has the fall in wage acted as a signal and an incentive in ex2?

Answer 10

It signalled to firms that there was a surplus in the labour market and it provided them with an incentive to hire more labour
The lower wage is also a signal to workers and provides them with the incentive to move alogn the supply curve - decrease - offering less of their services at the lower wage.

Question 11

What was the overall impact of the fall in wage (price of labour)

Answer 11

There occured a reallocation of labour resources with firms now producing output with a larger quantity of labour.

Question 12

Rationing

Answer 12

A method of apportioning or parcelling out goods and services among consumers or households

Question 13

Price rationing

Answer 13

The use of prices freely determined in markets - whether or not a consumer will get the good is determined by its price ( is the consumer willing and able to buy the good)

Question 14

Allocative efficiency

Answer 14

Producing the quantity of goods mostly wanted by society

Question 15

Marginal benefit

Answer 15

The extra benefit that you get from something. interpreted to represent the consumer’s willingness to pay.

Question 16

Why is a demand curve known as a marginal benefit curve?

Answer 16

Since marginal benefit decreases as the quantity of a good consumed increases, consumers will be willing and able to buy an extra unit of the good only if its price falls.

Question 17

Marginal cost

Answer 17

The extra cost of producing one more unit of output.

Question 18

Why is a supply curve known as a marginal cost curve.

Answer 18

Since marginal cost increases as the quantity of a good produced increases, producers will be willing to produce and sell an extra unit of the good only if its price increases.

Question 19

In terms of MB and MC where is market equilibrium

Answer 19

MB=MC

Question 20

Consumer surplus

Answer 20

The highest price consumers are willing to pay for a good minus the price actually paid.

Question 21

Where is the consumer surplus on a diagram

Answer 21

The area under the demand curve and below the price paid by the consumer, up to the quantity purchased. Top triangle

Question 22

Producer surplus

Answer 22

The price recieved by firms for selling their good minus the lowest price they are willing to accept.

Question 23

Where is producer surplus on a diagram

Answer 23

Shown as the area above the firm’s supply curve and below the price recieved by firm, up to the quantity produced. Bottom triangle.

Question 24

Social surplus

Answer 24

The sum of the producer and consumer surplus.

Question 25

Maximum Welfare

Answer 25

Amount of consumer and priducer surplus when MB=MC

Question 26

Adam Smith’s invisible hand

Answer 26

The market is able to coordinate the decisions of countless actions of individual economic decision makers without any central authority simply through the workings of demand and supply, while at the same time promoting efficiency which encourages the best allocation of scarce resources.

Question 27

Limitations to the concept of Allocative efficiency

Answer 27

1. Efficiency can only arise under a number of very strict and unrealistic conditions and in the real worls the market fails to achieve allocative efficiency - calling for goverment intervention
2. Competitive markets are unable to provide an answer to the for whom to produce question or output and income distribution.