Price determination and the price mechanism

Question 1

Define excess supply.

Answer 1

a situation in which the quantity that firms are willing and able to supply exceeds quantity that consumers demand at the going price.

Question 2

Define excess demand.

Answer 2

a situation in which the quantity that firms are willing and able to supply is less than the quantity that consumers demand at the going price.

Question 3

Does excess supply occur to the right or left of equilibrium on a supply/demand graph?

Answer 3

right

Question 4

Does excess demand occur to the right or left of equilibrium on a supply/demand graph?

Answer 4

left

Question 5

Define market equilibrium.

Answer 5

situation when the price is such that supply equals demand

Question 6

If there is excess supply, what will producers normally do to reduce their stocks?

Answer 6

reduce price

Question 7

If there was an advertising campaign about the benefits of eating apples, what would be likely to happen to price of apples and why?

Answer 7

increase in price, as demand curve would shift right

Question 8

If there was an advertising campaign about the benefits of eating apples, what would be likely to happen to price of bananas and why?

Answer 8

reduction in price, as demand curve would shift left, assuming apples are substitutes for bananas

Question 9

If new technology meant that watches could be produced more efficiently, what would be likely to happen to the price of watches and why?

Answer 9

price would reduce, as supply curve would shift left (as costs of making watches would reduce)

Question 10

If the government introduced stricter health & safety legislation in the building industry, what would be likely to happen to the price of new houses and why?

Answer 10

price would increase, as building costs would increase (eg more safety equipment needed), shifting supply curve to the right

Question 11

Define consumer surplus.

Answer 11

value that consumers gain from consuming a good or service over and above the price paid

Question 12

Which area on a supply/demand graph would show consumer surplus?

Answer 12

triangle formed by:
* (equilibrium quantity, equilibrium price)
* (0, equilibrium price)
* point at which demand curve touches x axis)

Question 13

Define marginal social benefit (MSB).

Answer 13

additional benefit that society gains from consuming an extra unit of a good or service

Question 14

If price increases, will this increase or reduce consumer surplus?

Answer 14

reduce (triangle gets smaller)

Question 15

If price increases, will this increase or reduce welfare that society receives from consuming the good?

Answer 15

reduce (as consumer surplus reduces)

Question 16

Define producer surplus.

Answer 16

difference between price received by firms for a good or service and the price at which they would have been prepared to supply it

Question 17

Which area on a supply/demand graph would show producer surplus?

Answer 17

triangle formed by:
* (equilibrium quantity, equilibrium price)
* (0, equilibrium price)
* point at which supply curve touches x axis)

Question 18

What two things add up to the increase in welfare to society from production and consumption of a good?

Answer 18

consumer surplus + producer surplus

Question 19

Define price mechanism.

Answer 19

process by which resource allocation is influienced through rationing, incentives and signalling

Question 20

Define price signal.

Answer 20

where price of a good or service carries information to producers or consumers that guides the market towards equilibrium, assisting in resoruce allocation

Question 21

Define marginal cost.

Answer 21

cost of producing an additional unit of output

Question 22

Does the government have a role in a free market economy?

Answer 22

yes, as it can’t function without a basic legal system including property rights, so as to give incentives for owners of capital