Micro Theme 1 CC3

• What is the Price Mechanism? 


  Use of market forces to allocate resources to solve the problem of what, how and whom to produce.
• What is Allocative Efficiency?


  The ‘right’ amount of resources being used to produce the ‘right‘ amount of each good/service. Occurs when marginal benefit is equal to the marginal cost.
• What are the functions of the Price Mechanism?

  • Signaling
  • Incentive
  • Rationing
• Signaling: 


  Helps to determine where and how resources should be allocated.

  E.g if prices are high, this signals to producers that demand is high and they should increase production for that product.
• Incentive: 


  When prices are high, this attracts producers into the market in search for higher profits. It encourages firms to become more efficient by investing in new technologies.
• Rationing: 


  When demand is bigger than supply, prices are bid up so that the good/service is rationed out to those who can afford to pay more. This is because resources are scarce.
• What is Rational Decision Making?

  Describes choices that are logical and consistent and maximize value.

  Rational consumers are purely self-interested, they want to maximize utility.
• What is Total Utility?

  Total amount of satisfaction obtained from consumption of a good/service.
• What is Marginal Utility?

  Satisfaction obtained from acquiring one more unit of a product.
• What is Diminishing Marginal Utility?


  Decreasing satisfaction as additional units of a product are acquired.
• What is a Fixed Rate Mortgage?


  Interest rate changed by the lender does not vary.
• What is a Variable Interest Rate Mortgage?

  Interest rate charged by the lender varies according to changes in the base rate.
• …. 


  Sometimes we act irrationally and buy things impulsively or out of habit. This is due to social norms and herd mentality.