Price Determination

Question 1

Define what the price mechanism is

Answer 1

The price mechanism is the interaction of supply and demand creating prices and sending signals to producers and consumers

Question 2

What are the three functions functions of the price mechanism

Answer 2

1. Signalling function
2. Rationing function
3. Incentive function

Question 3

What is the rationing function of the price mechanism

Answer 3

Whenever resources are particularly scarce, demand exceeds supply and prices are driven up to discourage demand and protect resources

Question 4

What is the signalling function of the price mechanism

Answer 4

Price changes send contrasting messages to consumers and producers on weather to join or leave a market

Question 5

What is the incentive function of the price mechanism

Answer 5

The incentive function is something that motivates a producer or consumer to follow a course of action or change behaviour

Question 6

What is the producer surplus

Answer 6

The producer surplus is the difference between the market price and the lowest price the producer would accept for the product

Question 7

What is the consumer surplus

Answer 7

Consumer surplus is the difference between the total amount of a good/service consumers are willing and able to pay and the amount they actually do pay

Question 8

What are indirect taxes

Answer 8

Indirect taxes are taxes our on products that you buy. The more expensive the product, the more indirect tax is added

Question 9

What is an example of indirect tax

Answer 9

VAT

Question 10

What are subsidies

Answer 10

A subsidy is an amount of money given directly to firms by the GVMT to encourage production and consumption. It is meant to benefit all of society

Question 11

Name two benefits of subsidies on producers

Answer 11

1. Helps them survive as a business

2. Increases output of goods that society needs

Question 12

Name two reasons against subsidies

Answer 12

1. Larger firms get a larger subsidy than smaller firms
2. Tax money spent on that instead of other things
3. Costs will have to be met through tax increases
4. Can cause firms to become inefficient as rely on subsidies

Question 13

Name 2 benefits of subsidies on consumers

Answer 13

1. Can buy essential products cheaper

2. Helps low income families to live better

Question 14

Name 2 disadvantages of taxes

Answer 14

1. Difficult to measure the level of externality so hard to quantify the tax required
2. If demand is inelastic then taxes will not reduce demand much
3. Taxes cause social inequality as takes a higher percentage of poorer incomes
4. Possibility of tax version (eg - illegal waste dumping)

Question 15

Name 2 benefits of taxes

Answer 15

1. Social efficiency (where MSC = MSB)
2. Provides incentive to reduce the negative externality
3. Taxes raise huge GVMT revenue