Price mechanism

Question 1

define price mechanism

Answer 1

way in which the basic economic problem is resolved in a market economy
= refers to the way in which prices are determined in a market economy through the interaction of supply and demand. It acts as a signaling and incentive system, helping allocate resources efficiently in a market

Question 2

describe functions of price mechanism if there’s excess demand

Answer 2

• firms may undergo excess demand or supply which is signalled by long queues, waiting lists etc
  = signal price is too low
• create incentive to increase price and increase Q supplied
  = satisfy excess demand= max profit
  = @ Q2,P2= no excess demand= been rationed away
• creates perf equilibrium
  = allocate scarce resources efficiently @ high price

Question 3

functions price mechanism if there’s excess supply

Answer 3

• Q supplied is higher than Q demanded
  = causes disequilibrium
• excess signalled by old stock not sold and can’t sell
  = signal P is too high
  = create incentive to decrease P to P1
  = liquidate and sell stock to make profit
  = cause contraction of S and extension of D
  = no more excess pulley
• resources allocated @ new P2

Question 4

adv free market price mechanism (free market economy)

Answer 4

• will get allocative efficiency where S=D
  = no LR disequilibrium= firms have strong understanding of price mechanism functions= no risk of excess demand or supply
  = less burden on consumers and producers
• encourage comp= lead to low prices and high Q= more choice
  = better qual as firms are competing w each other to give consumers what they want
  = incentivise firms to have low COP= low prices
• dynamic efficiency= high re-investment of supernormal profits
  = more tech advancements, R+D etc= new innovative goods for consumers
  = low COP for firms in LR= low prices and more choice
• Q @ max level= labour is derived demand= high job creation
  = higher Q produced= higher RGDP= growth
• consumers have freedom, liberty and choice to consume wo being cohered or forced into doing things gov say= better SOL

Question 5

disadv of free market price mechanism (free market economy)

Answer 5

• no guarantee of allocative efficiency
  = markets can fail= based on assumptions e.g. no perf info, no guarantee firms are profit maximisers= may ignore negative externalities and need of public goods etc
• can create price that deprives others from accessing goods
  = increase inequity due to inequality= decrease access to necessity goods
• firms may create excessive profit by cost-cutting in dangerous areas like health and safety, wages, environmental standards etc
  = create societal concerns
• high risk of create destruction= high profits mean more firms incentivised to enter= more innovation and comp
  = creativity can destroy pre-existing firms= high unemployment
• prices can be volatile in commodity and agricultural markets
  = demand and supply may be price elastic
  = volatile prices= high prices burden consumers and low prices burden producers

Question 6

general functions of prices in free market

Answer 6

• allocate scarce resources efficiently
• prices incentivise producers
• ration scarce resources by encouraging or discouraging consumption
• signal excess supply and need to increase or decrease resources