PRICE MECHANISM Flashcards
What happens when there is excess demand
Consumers bid up the price, increasing quantity supplied until the equilibrium price is reached.
If there is excess supply what happens
Producers will drop their prices to eliminate excess supply.
When price goes up what happens to the demand and supply curves
extension in the supply curve
contraction in the demand curve
When price goes down what happens to the demand and supply curves
extension in demand curve
contraction in the supply curve
There is currently excess demand (or a shortage) in the market. Explain how the price adjusts to bring the market back to equilibrium. (4 key points)
When there is a shortage of a good, consumers will bid up the price.
This signals to and incentivises producers to supply more, leading to an extension in supply.
It also rations how much consumers demand, leading to a contraction in demand.
This brings us to a new equilibrium at a higher price.
There is currently excess supply (or a surplus) in the market. Explain how the price adjusts to bring the market back to equilibrium. ( 4 key points)
When there is an excess supply of a good, producers will decrease the price to sell off their surplus.
The decreasing price signals to producers to supply less, and reduces incentive to supply, leading to a contraction in supply.
It also increases quantity demanded because consumers will buy more goods as price decreases.
This brings us to a new equilibrium at a lower price.
Functions of the price mechanism (3)
Signalling: higher prices signal to producers that consumers want more of their goods, so producers supply more of them. Lower prices signal to producers that consumers want fewer of their goods, so producers supply fewer of them.
Incentivising: higher prices increase the incentive to supply, because producers can make more profit. Lower prices decrease the incentive to supply, because producers make less profit.
Rationing: higher prices ration (or limit) goods to the consumers who will pay the most.
