price mechanism

• price mechanism


  refers to the system of resource allocation based on the free movement of prices, these prices being determined by the interaction of demand and supply curves
• total revenue can be calculated using a supply and demand curve
• TR= area of OP1AQ1

  (p1 x q1)

  
• increased chocolate price = increased production costs - shifts supply left from s to s1

  
• how has increased chocolate price effected total revenue?

  TR was OP1AQ1, and is now OP2AQ2

  TR has increased (the area is bigger)

  
• what is TR dependant on?


  if supply is shifting, TR is dependant on the shape of the demand curve
• if demand curve is relatively steep (inelastic) TR will increase

  
• if demand curve is shallow (elastic) the TR will fall

  
• exam q example

  
• check that supply and demand curves, match expectations

  e.g increase or decrease in price and quantity
• check supply and demand curves match what you would expect

  e.g increase and decrease for price and quantity

  
• What does the supply curve represent in terms of societal cost?


  The supply curve represents the cost to society of producing goods and services.
• What does the area under the supply curve indicate?


  The area under the supply curve indicates the value of resources used in producing a product.
• How does the market mechanism allocate resources?


  • Brings together buyers and sellers
  • They agree on a price for the product or service
  • Coordinates individual decisions through price movements
• What happens when buyers want to purchase more than sellers want to sell?

  Prices will rise as a result of increased demand.
• How do higher prices affect buyer and seller behavior?


  Higher prices make buyers more reluctant to buy and sellers more willing to sell.
• What is the mechanism called that coordinates individual decisions through price movements?


  This mechanism is known as the price system.
• functions carried out by the price mechanism to allocate resource:

  • rationing
  • signalling
  • incentive
• what is rationing 


  • economy has limited resources, unlimited wants
  • price increases, people can no longer afford the good
  • limited resources become easily and efficiently allocated to those that can afford them
• rationing (simple)


  if you can afford it, you get it
• what is signalling


  • uses demand and supply curve to highlight where resources are needed
  • when prices rise, signals that economy should move more resources into manufacturing of that product
• signalling (diagram)


  a shift in demand from d to d2, causes price to increase from p1 to p2

  • price increase- acts as signal to increase production of good from q1 to q2
  • to increase production, firm needs to increase to amount of resources being used in this industry (shaded area)

  
• signalling (simple)


  follow demand
• what is incentive (simple)


  motivation for all parties in economy
• what is incentive

  • buyers - more money, means greater the ability to acquire goods they want (increased utility)
  • suppliers - producing more of the goods people want, makes more money (increased utility)
• majority of economic systems are based on price mechanism, due to its power and efficiency to allocate resources
• price mechanism has productive efficiency and allocative efficiency
• productive efficiency exists when production is achieved at the lowest cost possible (economy is operating on the ppf)
• why is it impossible to be on ppf and not have productive efficiency?


  ppf shows maximum that an economy can produce
• What allocates all resources in a free market economy?

  The price mechanism
• How does the price mechanism function in a free market economy?


  It allocates resources efficiently
• What is the aim of any economic system according to the study material?


  To maximize the level of satisfaction or welfare in society
• How is welfare generally defined in economics?


  As the satisfaction or benefit gained from the production and consumption of economic goods
• Who are the main participants in economic activity?


  Producers and consumers
• What must be maximized for an efficient allocation of resources to exist?

  The benefit of producers and consumers
• What are the key concepts introduced in relation to a free market economy?

  • Price mechanism allocates resources
  • Efficient allocation of resources
  • Welfare economics
  • Allocative efficiency
• allocative efficiency occurs when no one can be made better off without making someone else worse off
• allocative efficiency (simple)


  maximises what people can receive
• aim of allocative efficiency


  maximise level of welfare/ satisfaction
• welfare 


  satisfaction gained from the production/ consumption of goods