Price Mechanism

Question 1

What is a market

Answer 1

A market refers to any place where buyers can meet suppliers and exchange goods and services

Question 2

What is the market equilibrium

Answer 2

• when demand is equal to supply
• the market equilibrium is the market clearing price and quantity

Question 3

What is market disequilibrium

Answer 3

Market disequilibrium occurs when demand is not equal to supply
- when there is excess demand
- excess supply

Question 4

How is the market disequilibrium solved

Answer 4

In a free market, the market disequilibrium is solved using the functions of the price mechanism

Question 5

What are the functions of the price mechanism

Answer 5

• signal
• incentive
• rationing
• allocation of resources

Question 6

How does the price mechanism work when the price is too Hugh

Answer 6

• the signalling function sends signals to the producers of the price being too high -> this includes excess stock in warehouses
• this gives the producers the incentive to reduce the price as by lowering the price they can sell this excess stock and profit from it
• the this then rations out this excess supply
• a perfect allocation of resources has occurred and the market is in equilibrium

Question 7

How does the price mechanism work if the price is too low

Answer 7

• the price mechanism sends a signal that the price is too low -> this is through long queues excessive waiting lists
• this gives producers the incentive to raise the price so they can capitalise on this high demand
• this rations out this excess demand
• allowing for a perfect allocation of resources and the equilibrium to be achieved