Evaluating the functions of the price mechanism

Question 1

Define and explain the price mechansim

Answer 1

Price mechanism – the method through which the market allocates scarce resources by responding to changes in the conditions of supply and demand. Prices create signals and incentives to determine what is produced, how it is produced and who receives the product.

Question 2

Name the three ways the price mechanism works

Answer 2

Rationing, signalling and incentives

Question 3

Market equilibrium =

Answer 3

market clearing price

Question 4

Excess supply =

Answer 4

s > d, triangle above equilibrium, price down signalling

Question 5

Excess demand =

Answer 5

– d > S, triangle under equilibrium, shortage in the market pushing prices up and causing firms to supply more so demand contracts allowing supply and demand to meet causing a market clearing price or causing rationing

Question 6

Adam smith called the price mechanism

Answer 6

the invisible hand of the market

Question 7

Explain incentives

Answer 7

Incentives - price of product rises creating incentive for firms to shift production towards product that help generate higher profits and vice versa

encourages a change in behaviour of a consumer or producer e.g. high price encourages firms to supply more to the market as its more profitable

Question 8

Explain signalling

Answer 8

Signalling - price of product rises signalling to producers demands high so increase production and encourages consumers to reduce demand and therefore leave the market shifting the demand and supply curves

price acts as a signal to consumers and new firms entering the market. the price changes show where resources are needed in the market. a high price signals firms to enter the market because its profitable however this encourages consumers to reduce demand and therefore leave the market shifting supply and demand.

Question 9

Explain rationing

Answer 9

Rationing - due to scarcity, d>s, prices rise so goods rationed to those who can afford them

when there are scarce resource, price increases due to the excess of demand. The increase in price discourages demand and consequently rations resources, this is a disincentive to consumers.

Question 10

When drawing excess supply/demand draw on the x axis

Answer 10

the quantity demanded and supplied either side of quantity of equilibrium

Question 11

Local market, national market, global market examples

Answer 11

hairdressers, cafes
supermarkets, restaurant chains
gold, oil