Unit 1: Price Mechanism

• What is the price mechanism? What is its influence?

  Interaction of demand and supply in a free market. This interaction determines prices.
• What are the functions of the price mechanism?

  Allocation of resources at equilibrium, Ration resources, Signaling, and Incentive producers.
• What is the difference between scarce and surplus resources, and their effect on prices?

  Scarce resources will increase prices and Surplus resources will decrease prices.
• How does signaling work?

  Consumers signal their willingness to pay to sellers, and producers signal their willingness to sell to consumers
• What is the difference between required and unrequired resources, and its effect on price?

  Required resources cause an increase in price and unrequired resources result in a fall in prices
• What happens when prices rise according to ARSI?

  1-Signal excess demand and need for more resources, 2-Incentivise firms to increase output and profits, 3-Ration resources by lowering consumption, 4-Allocate resources efficiently
• How is a price rise demonstrated graphically?

  The demand curve shifts to the right, the demand curve contracts, and the supply curve extends
• What happens when prices fall?

  Signal excess supply and need for less resources, Incentivise firms to lower output and increase profit, ration resources by increasing consumption.
• How is a fall in price shown graphically?

  The supply curve shifts right, supply curve contracts, and demand curve extends
• What principle are the functions of the price mechanism built on? (Exam tip)

  Self-interest. Every party (producers and consumers) acts based on their interest. Each function can be explained through self-interest.