Price mechanism and economic systems (Pack 4)

• How is equilibrium price and quantity determined?

  • Intersection of demand and supply curves
  • Price where quantity demanded equals quantity supplied
• What is the definition of 'equilibrium price'?

  Price where supply equals demand and there’s a balance in the market with no tendency to change
• What does excess demand and excess supply indicate on a diagram?


  • Excess demand(Shortage): Quantity demanded > Quantity supplied (Under the equilibrium)
  • Excess supply(Surplus): Quantity supplied > Quantity demanded (Above the equilibrium)
• What are the three functions of the price mechanism?

  1. Rationing function (Consumers willing bid up the price due to limited supply until equilibrium is reached)
  2. Incentive function (Information from consumers is sent to the producers of their wants and needs)
  3. Signalling function (Other firms see the changes and may choose to reallocate their resources to the more profitable market)
• How do rising costs impact price and quantity in a demand and supply diagram?

  • Supply curve shifts left
  • Price increases, quantity decreases
• How does rising demand affect price and quantity in a demand and supply diagram?

  • Demand curve shifts right
  • Price increases, quantity increases
• What is a 'free market economy'?

  An economic system with no government intervention
• Name 2 economists who support a free market economy.

  Adam Smith and Friedrich Hayek
• What are the pros and cons of a free market economy?

  
  

  Pros:

  • Competition means firms have more incentive to produce what consumers want (good quality at low prices)
  • More firms means a greater consumer choice

  Cons:

  • Monopolies may form meaning less choice and high prices
  • Public goods won’t be provided in a pure free market
• What are the pros and cons of a command economy?

  Pros:

  • Government is likely to consider impacts on third parties
  • Lower unemployment as government can create jobs
  • Government can provide public goods

  Cons:

  • No price mechanism so shortages and surpluses are common as government has limited information
  • Lack of competition means less choice and quality for consumers
  • Lack of financial incentives so workers won’t work as hard
• What is the definition of 'command economy'?

  An economic system where the government controls the allocation of resources
• Name one economist who supports a command economy.

  Karl Marx
• What is a 'mixed economy'?

  An economic system combining free market and government control
• What are three goods/services provided by the government in most mixed economies?

  • Education
  • Healthcare
  • Public transportation
• Why does the government provide education in a mixed economy?

  To ensure equal access and improve society
• What are three reasons why consumers may not act rationally?

  1. Herding behaviour (Influenced by what others are consuming)
  2. Habitual behaviour (Sticking to current situation)
  3. Weakness at computation (Exaggerating small probabilities, if consumers are addicted, anchoring to nearby reference points and going back to their default option e.g. letting their subscriptions carry on)