LS16- Price Mechanism

Question 1

Prices rising signals (price mechanism)

Answer 1

• signal excess demand and need for resources
• incentivise firms to increase output to increase profit - shown by a extension along the supply curve
• ration resources by decreasing consumption and therefore QD
• allocative efficiency achieved

Question 2

Prices drop signals (price mechanism)

Answer 2

• signals excess supply and need for resources
• incentivises firms to reduce output to increase profit (liquidating stocks)
• ration scarce resources by consumption
• allocative efficiency achieved at equilibrium

Question 3

Price changes impact on revenue when demand is elastic

Answer 3

decrease in price leads to an increase in total revenue
increase in price results in a fall in total revenue

Question 4

Price changes when demand is inelastic

Answer 4

decrease in price leads to a fall in total revenue
increase in price leads to a rise in total revenue

Question 5

Functions of the price mechanism

Answer 5

Signalling function, incentive function, rationing function