1.2.6 - price determination

key term - Market equilibrium

a situation that occurs in a market when the price is the quantity that consumers wish to buy is exactly balanced by the quantity that firms wish to supply

where does market equilibrium exist

Pe and qe

what happens when price is higher then Pe

excess supply

decrease price

what happens when price is lower then Pe

excess demand

increase price

key term - comparative static analyis

examines the effect on equilibrium of a change in the external condition affecting the market.

price determination

the process through which the interaction of supply and demand to determine prices

price mechanism (3 factors)

• price signalling

• incentivising

• rationing

describe how changes in consumer preferences affects the market equillibrium

the initial equilibrium shows p0 and quantity traded of Q0

the likely change is an increase in demand as peoples preference changes shift the demand curve to the right

new equillibrium is Q1 and P1, there will be excess demand

market forces will cause price to shift from p0 to p1, which will lead to an extention in supply as more producers are willing to supply at a higher price

explain the rationing effect

• allocate and ration scarce resources

• if many consumers demand a good, but supply is scare = high price

• limited supply will be rationed

• to those willing to pay the highest price. This mechanism ensures that resources are distributed efficiently among consumers based on their willingness to pay.

define incentive function

motivates producers or consumers to follow a course of action to change behaviour.

It encourages production or consumption through financial benefits or penalties.

signalling - funtion of a price mechanis,

rising prices signals to consumers to reduce demand - signals producers to adjust output levels to reduce excess supply and restore market equilibrium.