Some core introductory revision notes on the economics of market activity.
An imbalance between supply and demand in a market
When demand exceeds supply at the current market price – this leads to shortage and puts upward pressure on price
When supply exceeds demand at the current market price – this leads to a surplus and puts downward pressure on price
INCENTIVE FUNCTION OF PRICES
Higher market prices provide an incentive for producers to supply more as they signal the possibility of revenue and increased profits. They might encourage new firms to enter the market
Markets are platforms where buyers and sellers come together to determine prices and allocate scarce resources
In equilibrium, there is a state of balance between market demand and supply.
The market-clearing price is a price where quantity demanded, and quantity supplied are in balance meaning no surplus or shortage.
Forces of demand and supply representing the aggregate influence of self-interested buyers and sellers on price and quantity of the goods and services offered in a market.
RATIONING FUNCTION OF PRICES
Whenever resources are scarce, demand exceeds supply and prices are driven up. Higher prices reduce the real purchasing power of someone’s income and discourage demand and help to conserve resources.
SIGNALLING FUNCTION OF PRICES
Changes in market prices send important signals to both consumers and producers. Higher prices signal possible higher revenues and profits for suppliers. Lower prices are a signal to consumers that their ability to buy goods and services has grown.
Draw a diagram to show the effects on the market for a good of an increase in wages (ceteris paribus).
Increase in wages – assuming productivity remains the same – leads to an inward shift in the supply curve from S1 to S2.
The equilibrium price rises to P2 and, as a result, quantity demanded contracts from point A to B
Chain of reasoning - increase in demand
Chain of reasoning - increase in supply
Give two advantages and two disadvantages of allowing the price mechanism to operate without any government intervention:
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