3.1.5.1 HOW MARKETS AND PRICES ALLOCATE RESOURCES

Define price mechanism

How prices are deteemined in a market through the interaction of demand and supply, and how their prices allocate resources efficiency

Examples of a price mechanism?

• poor harvest of wheat

• supply falls

• prices rise

• consumers buy less (rationing)

• farmers are encouraged to grow more in the future (incentive)

What did Adam Smith call this theory?

The invisible hand theory

Give an example of an app that involves price mechanism?

Vinted

What are the 4 aspects to price mechanism?

• allocate

• rationing

• signaling

• incentive

What does rationing function of the price mechanism mean?

How prices allocate scarce goods and services among consumers

Example of rationing function in terms of concert tickets?

Shortage of concert tickets

• demand is high

• supply is limited

• prices increase

• only people willing and able to pay back the higher price will get the tickets

What does the rationing function of price mechanism ensure?

• ensures scarce resources aren't over consumed

• allocates goods without needing government intervention

What type of good is oil?

A commodity

Where are commodities sold?

On the global market

What is the most stable commodity?

Gold

What does signaling function of the price mechanism mean?

Refers to how price changes convey information to both consumers and producers about what is happening in the market

How do consumers and producers respond to prices rising?

• consumes respond by buying less when prices rise

• producers respond by increasing supply when prices rise

What does rising prices signal?

Raising prices signals that a good is becoming more scarce, or demand has increased

Who are “agents?

Consumers and producers

Give example of how increasing oil prices, affects consumers and producers?

Oil prices increase

• signals that oil is scarce

• many cut down on usage

• firms may increase supply (signals it is more profitable)

Why may cause cocoa prices to decrease?

• increase in supply/production

• less demand

What are 5 conditions of market demsnd for cocoa?

• incomes

• relative prices of cocoa substitutes

• changing consumer tastes and preferences

• derived demand

• speculative demsnd

Why does cocoa have derived demand?

It depends on the demand for chocolate

Why do cocoa prices fluctuate?

Could be due to natural disasters (linking to scarcity of resources)

What are the 6 conditions of market supply for cocoa?

• weather conditions

• climate change

• rate of capital investment in cocoa farming

• productivity of cocoa plantations

• impact of innovation in cocoa growing to improve yields

• prices/potential profits from growing alternative crops

What economic agents do cocoa prices send signals to?

• cocoa farmers/growers

• export company

• cocoa bean grading company

• shipping business

• cocoa processor

• manufacturer - such as a confectioner

• retailer of cocoa based products

Cocoa prices volatility

What are global demsnd fluctuations?

Demand for chocolate changes based on consumer tastes, economic conditions and trends

• sudden increases or decreases in demand can cause cocoa prices to rise and fall quickly

Cocoa prices

What are speculative factors?

Some investors may buy cocoa contracts hoping prices will rise

• this extra buying can push prices up, and when they sell, it can cause prices to fall, adding to volatility

What does price volatility mean?

How much and how quickly prices rise and fall over time

Why are price volatile in markets? And examples

• changes in supply (global harvests)

• changes in demand (trends, income changes)

• speculation (investors)

• external shocks (weather, conflicts)

Are commodity prices volitate?

Yes they fluctuate

What are emerging markets?

Countries that are starting to specialize in something (NICS/BRIC nation)

Give Exmaples of supply side shocks?

Droughts, tsunamis, portage famine (Ireland)

What does the price volatility depend on?

The elasticity (steepness of the curve)

What are inter-related markets?

Many goods are linked either in production or consumption, so s change in one market, often spills over onto others through price mechanism

So what happens to demsnd when supply increases, in an inter-related market?

Supply increases in one market, which reduces demand in the subsitutes market

When does a marker reach equilibrium?

When demand = supply

So if the price is £9, and the market is in equilibrium, what does it mean for all other prices?

Market disequilibrium

If the price is lower than equilibrium, what happens to demand?

Demsnd is greater than supply

• excess demsnd

If the price is higher than equilibrium, what happens to supply?

Supply is greater than demsnd

• excess supply

Define allocate

Allocating scare resources among competing users

Define rationing

Prices serve to ration scare resources when market demsnd outstrips supply

Define signaling

Prices adjust to demonstrate where resources are required, and where they are not

Define incentives

When the prices of a product rises, quantity supplied increases as businesses respond

As wagu beef becomes more popular, what happens to price, demsnd and supply?

• demsnd increases

• supply increases

• creates an incentive for farmers to increase production (as it is more profitable)

• movement along the supply curve

• new equilibrium

When there is a supply side shock and prices decrease, how does the rationing function of prices help solve this problem?

• prices begin to rise

• reduces demsnd

• new equilibrium (limited supply)

What do high prices signal? What do low prices signal?

High prices signal that a good is not in short supply, encouraging producers to enter the market

Low prices suggest resources should be moved elsewhere

What is producers and consumers incentives when prices rise?

A producer - rising prices, increases potential profit, so they expand production

A consumer - seek substitutes, which reduces demsnd

What is the basic economic problem?

Unlimited needs and wants but limited resources - creates an opportunity cost

SO, what is the main function of price mechanism?

Protects scare resources

What does the rationing function mean when prices rise?

• when resources are scarce, its prices rise

• only those willing and able to pay the higher prices, consume the good