Price Mechanism

Question 1

4 Functions of money

Answer 1

1. medium of exchange - enables buying + selling of products, making the exchange easier
2. measure of value - enables a value to be place on products so they can be bought and sold w/ ease + enables comparisons between relative value of products
3. store value - convient way of storing wealth so it can be spent at a later date
4. method of deferred payment - enables borrowing and lending (rate of interest is the price which is set for b & l)

Question 2

rational decision making def

Answer 2

assumptions:
consumers will allocate their expenditure (disposable money) on goods and services to maximise utility
producers will allocate their resources to maximum profits

Question 3

Price mechanism: 3 functions of price

Answer 3

eliminates excess demand / supply until equilibrium is reached
1. rationing - price reflects scarcity
e.g. scarce = high price + consumers are only willing + able to buy goods they can afford = price limits quantity demanded = goods are only given to those who are prepared to pay the most = consumers bid up the price = prices other consumers out of the market = forced to find cheaper alternatives = rid of excess demand
2. incentive
lower price = utility maximising consumers gain incentive to purchase more = rid of excess shortage = equilibrium
higher price = give profit maximising producers to supply more goods (more profit = able to cover extra costs involved w/ increasing output) = rid of excess demand = equilibrium
3. signalling functions
price carry info for consumers + producers / reflect market conditions and if they have changed + reflect on decision of all economic agents

Question 4

best way to show price mechanism

Answer 4

supply - demand diagram