1.2.7 Price mechanism

Question 1

How is price determined?

Answer 1

By the interactions of demand supply.

Question 2

When do prices rise?

Answer 2

When buyers want to purchase more than suppliers want to sell, encouraging suppliers to sell more as they will be able to make higher profit.

Question 3

What are the three functions of Price Mechanism?

Answer 3

• The rationing function
• The signalling function
• The incentive function

Question 4

Explain the rationing function of Price mechanism.

Answer 4

• The price system is a way of rationing goods because when price increases, some people will no longer be able to afford to buy the product and others may no longer have the desire to buy the good
• The limited resources can be rationed and allocated to the people who are able to afford them and those who value them most highly

Question 5

Explain the Signalling function of Price mechanism.

Answer 5

• Price mechanism acts as a signal where resources should be used
• When prices rise, producers move resources into the manufacture of that product
• The change in price indicates to suppliers and consumers that market conditions have changed so they should change the quantity bought and sold- when price equilibrium moves, output equilibrium moves with it

Question 6

Explain the incentive function of Price mechanism.

Answer 6

• It acts as an incentive for people to work hard
• Buyers realise that the more money they have, they are able to buy more products
• Suppliers realise that if they produce more of the goods, they will make more money
• Low prices also acts as an incentive for consumers to buy more of a good and high prices act as an incentive to suppliers to sell more of a good.
• The price mechanism encourages people to behave a certain way

Question 7

Explain Price mechanism in the context of a local market

Answer 7

• COVID has disrupted supply chains across the planet, and many countries have blocked imports to prevent the spread of the virus.
• If we take the example of British supermarkets, less imports from other countries means there are fewer goods on supermarket shelves.
• As the demand for food is high but the supply is low, the price of food rises to ration off the excess demand so that only the consumers who value the food most highly buy them.
• This is an example of the rationing function .

Question 8

Explain Price mechanism in the context of a national market.

Answer 8

• The price of housing differs across the UK, from being high in the south and low in the north.
• There are multiple reasons to explain these discrepancies. London,
  not only the capital, is the second largest financial centre in the world, as well as home to many tourist attractions.
• As the population of London is high relative to the rest of the UK, house prices will rise through the rationing function , i.e. to ration off
  excess demand and only provide houses to those who value them the most.
• The high house prices in London also offer an incentive for firms to allocate resources to the production of more houses, as there is profit to be made in this industry.
• This is an example of the incentive function .

Question 9

Explain Price mechanism in the context of a global market.

Answer 9

• In 1973 the Organisation for Petroleum Exporting Countries (OPEC)
  proclaimed an oil embargo (i.e. restricted the supply of oil on an insurmountable scale), due to geopolitical factors regarding America and the Middle East.
• This sent the price of oil at record-breaking levels across the planet, as oil was an invaluable resource to countries.
• This perfectly exemplifies the rationing function because the
  disequilibrium of supply and demand meant the high prices deterred consumers who didn’t value oil highly, which left the market open only to those consumers who did.
• By raising the price of oil, the market once again returned to a state of equilibrium.