Topic 4 - Market Equilibrium and Interrelationships

Question 1

Market mechanism =

Answer 1

• Rising price of a good would result in a firm expanding production (profit maximisation)
• Results in a consumer contracting demand - tries to maximise utility with his limited resources
• MM reconciles differences through price system

Question 2

Market Equilibrium =

Answer 2

• Price mechanism rations scare supply based on consumer’s ability to pay.
• The ‘invisible hand’ of the market ensures that prices are at equilibrium level.
• In the long run, markets will always reach equilibrium.

Question 3

Market Disequilibrium (Excess Supply) =

Answer 3

• If firms set their price too high, there will be excess supply.
• Level of supply exceeds level of demand
• Abundance of goods in the market
• Disequilibrium position
• Firms will be forced to sell their goods at a lower price and price will fall towards equilibrium level.

Question 4

MD (Excess Demand) =

Answer 4

• If firms set their price level too low, there will be an excess demand.
• Shortage of goods in the market
• Disequilibrium position
• Prices will rise towards equilibrium level as firms raise their prices.

Question 5

The Signalling Function (Price mechanism 1)

Answer 5

Prices signal what is available, conveying information to produce and consumers

Question 6

2 - The Incentive Function

Answer 6

Prices create incentives for agents to behave in ways consistent with their self interest.

Question 7

3 - The Rationing Function

Answer 7

• When resources are particularly scarce, demand exceeds supply and prices are driven up
• Effects of price rise is to discourage demand, conserve resources and spread out their use overtime

Question 8

4 - Allocative Function

Answer 8

Changing relative prices allocate scarce resources away from markets which exhibit supply and into markets where there is excess demand.