MICRO - LS16 - Price Mechanism

Question 1

What is the price mechanism

Answer 1

It’s how price allocates goods and services in a market based on the levels of demand and supply

Question 2

What are the functions of the price mechanism

Answer 2

1) Signalling function
2) Incentive function
3) Rationing function

Question 3

Signalling function

Answer 3

If the price rises it signals to the firm to produce more of the product, consumers are willing to pay for the change in price
Acts as a signal as to where resources should he used

Question 4

Signalling function example

Answer 4

A change in price provides information both to produces and consumers about changes in market conditions

Question 5

Incentive function

Answer 5

Incentive for the supplier to produce more/less of a good
if supply decreases, incentive is to rise price as competing more
If demand increases so will price but not to the same proportion as demand does as it then increases revenue
Encourages people to work hard - buyers able to have more money and buy more
As suppliers produce more, revenue increases
Low prices encourage consumers, high encourage suppliers

Question 6

Incentive function example

Answer 6

An increase in demand, leading to a rise in piece, will encourage firms to increase production

Question 7

Rationing function

Answer 7

only affects consumer
When the price increases some consumers will not be able to afford to buy the good/service or they may no longer have the desire to do so, limited resources allocated to those who can afford them and those who value them the most highly

Question 8

Rationing function example

Answer 8

When there is a shortage of a product, the price will rise and deter some consumers from buying the product

Question 9

When demand is price elastic a decrease in price results in…

Answer 9

…an increase in total revenue

(Will cause QD to increase and therefore total revenue)

Question 10

When demand is price inelastic a decrease in price results in…

Answer 10

….a decrease in total revenue
(Decrease in price will be the LARGEST proportionate change (QD is inelastic) therefore QD is very little change therefore this reduces total revenue (as less TR earned from fall in price)

Question 11

When demand is price elastic an increase in price results in…

Answer 11

…….A decrease in total revenue
(Will cause QD to decrease and therefore total revenue)

Question 12

When demand is price inelastic an increase in price results in…

Answer 12

… an increase in total revenue

(There is still some change but smaller then price increase so revenue increases)

(An increase in price will be the LARGEST proportionate change (OD is inelastic) therefore QD is very little change therefore this increases total revenue (as more TR earned from the rise in price)

Question 13

Price mechanism - local context

Answer 13

• The coronavirus pandemic has disrupted supply chains across the planet, and many countries have blocked imports to prevent the spread of the virus.
• If we take the example of British supermarkets, less imports from other countries means there are fewer goods on supermarket shelves.
• As the demand for food is high but the supply is low, the price of food rises to ration off the excess demand so that only the consumers who value the food most highly buy them.
• This is an example of the rationing function.

Question 14

Price mechanism - National context

Answer 14

• The price of housing differs across the UK, from being high in the south and low in the north.
• There are multiple reasons to explain these discrepancies.
• London, not only the capital, is the second largest financial centre in the world, as well as home to many tourist attractions.
• As the population of London is high relative to the rest of the UK, house prices will rise through the rationing function, i.e. to ration off excess demand and only provide houses to those who value them the most.
• The high house prices in London also offer an incentive for firms to allocate resources to the production of more houses, as there is profit to be made in this industry.
• This is an example of the incentive function.

Question 15

Price mechanism - Global context

Answer 15

• In 1973 the Organisation for Petroleum Exporting Countries (OPEC) proclaimed an oil embargo (i.e. restricted the supply of oil on an insurmountable scale), due to geopolitical factors regarding America and the Middle East.
• This sent the price of oil at record-breaking levels across the planet, as oil was an invaluable resource to countries.
• This perfectly exemplifies the rationing function because the disequilibrium of supply and demand meant the high prices deterred consumers who didn’t value oil highly, which left the market open only to those consumers who did.
• By raising the price of oil, the market once again returned to a state of equilibrium.