free markets

Question 1

signalling

Answer 1

Prices adjust to demonstrate where resources are required, and where they are not
•Prices rise and fall to reflect scarcities and surpluses
•If prices are rising because of high demand from consumers, this is a signal to suppliers to expand production to meet the higher demand
•If there is excess supply in the market the price mechanism will help to eliminate a surplus of a good by allowing the market price to fall.

Question 2

rationing

Answer 2

• Prices serve to ration scarce resources when demand in a market outstrips supply.
• When there is a shortage, the price is bid up – leaving only those with the willingness and ability to pay to purchase the product.
• The popularity of auctions as a means of allocating resources is worth considering as a means of allocating resources and clearing a market.

Question 3

incentive

Answer 3

• Through their choices consumers send information to producers about the changing nature of needs and wants
• Higher prices act as an incentive to raise output because the supplier stands to make a better profit.
• When demand is weaker in a recession then supply contracts as producers cut back on output.

Question 4

price mechanism

Answer 4

The interaction of buyers and sellers in free markets enables goods, services, and resources to be allocated prices. Relative prices, and changes in price, reflect the forces of demand and supply and help solve the economic problem. Resources move towards where they are in the shortest supply, relative to demand, and away from where they are least demanded.