A2.01.10: Market Equlibrium + Price Mechanism Flashcards
Define the free market
Any place where buyers meet suppliers to exchange goods and services free from government intervention
2 other names for equlibrium?
Allocative efficiency or Market Clearing Position
Define equilibrium
Where demand equals supply
Define disequilibrium
Where demand does not equal supply
Define excess supply
When there’s more supply available in the market relative to effective demand from consumers (a.k.a a surplus in the market)
Define excess demand
When there’s more demand relative to supply at a given price (a.k.a a shortage in the market)
What are the functions of the price mechanism (the free market)
Prices are ARSI
A - allocate scarce resources efficiently
R - ration scarce resources by encouraging or discouraging consumption
S - signal the fact that there’s been excess demand / supply and there’s a need for increase or decrease of resources
I - incentivise producers to increase / decrease output to increase profit
How is excess demand shown on a D & S curve (or a shortage in the market)
Excess demand is at the bottom of equlibrium
How is excess supply shown on a D & S curve (or a surplus in the market)
Exces supply is above the equlibrium
What does it generally mean if there’s excess demand?
Prices increase as there’s a natural upwards pressure on prices therefore, reaching the equilibrium point again
What does it generally mean if there’s excess supply?
Prices decrease as there’s a natural dowwards pressure on prices therefore, reaching the equilibrium point again
What is true about disequilibrium and how long it lasts
Disequilibrium is said to be always temporary
Define Price Mechanism
The role of price as a signalling mechanism. incentive mechanism and rationing mechanism
How to structure 10 marker answer?
D/S Shifts right / left –> D/S Increases/Decreases at each and every price level –> excess demand/supply at Q3-Q1 –> shortage / surplus in the market –> upwards / downwards pressure on prices –> this sends a signal to suppliers that there’s a shortage / surplus and a need to increase/decrease resources–> upwards/downwards pressure on prices provides incentive to increase/decrease output to increase profit –> rationing of scarce resources by encouraging/discouraging consumption –> reallocation of scarce resources efficiently into the production of x.
At the same time, higher/lower prices increases/decreases consumption thus, Quantity supplied increases/decreases and quantity demanded increases/decreases until reaching a higher equilibrium where Quantity supplied is equal to quantity demanded at a higher/lower equilibrium price P2 and higher/lower equilibrium quantity of Q2.
