Price Mechanism

Question 1

Market

Answer 1

A place where buyers and sellers meet to exchange goods and services

Question 2

Price Mechanism

Answer 2

The market mechanism (supply and demand) uses price changes to allocate resources

Question 3

Functions of Price Mechanisms

Answer 3

Signalling Function - a higher price signals to firms to increase quantity supplied in order to maximise profit
Incentive Function - a lower price incentivises consumers to increase quantity demanded in order to maximise utility
Rationing Function - provides a method to allocate scarce resources - a shortage of supply will cause price to rise, rationing the availability of the good to those that can afford it

Question 4

Signal S+D diagram

Answer 4

Increase in demand (D to D1) creates excess demand
Excess demand causes prices to rise (P to P1)
Higher price signals to firms to increase quantity supplied (Q to Q1) to maximise profit

Question 5

Incentive S+D diagram

Answer 5

The increase in supply (S to S1) creates an excess supply
The excess supply causes prices to fall (P to P1)
The lower prices incentivise consumers to increase quantity demanded (Q to Q1) to maximise utility

Question 6

Ration S+D diagram

Answer 6

The decrease in supply (S to S1) creates an excess demand
The excess demand causes the price to rise (P to P1)
The higher price rations the availability of the good to those consumers that can afford it so quantity demanded falls (Q to Q1)