Price mechanism
Process in a market economy where consumers and producers interact to determine the allocation of scarce resources
3 main price mechanism
- Signalling function
- Incentive function
- Rationing function
How does signalling function work?
- Consumers signal to producers on the qty to produce by increasing demand on goods through casting dollar votes
- Demand increases from D1 to D2. At initial price at P1, there will be a shortage
- Thus, leading to a upward pressure on price
- This will then signal to producers to allocate more resources to increase production of goods and services due to possibility of earning greater profits
- Quantity sold increases from Q1 to Q2
How does incentive function work?
- producers are competing for spending votes of consumers
- consumers buy from producers which offer a lower price
- producers will be incentivised by the profits
- find a lower cost production method
How does rationing function work?
- Prices ration goods to comsumers who are willing and able to pay
- depends on the income, prices and preferences
- increase in price drives out people who are unable or unwilling to pay
- decrease in qauantity demanded
Price of substitute falls
Decrease in demand of good due to change in price of related good/substitute.
- Demand curves shift left
Population rises
Change in population, change in number of consumers
- Demand increases
Taste shift away from good due to strong advertising
Change in taste and preferences
- Decrease in demand
Price of complementary good falls
Change in price of related good
- Increase demand of good
The good increase in price
The price of good changes directly.
- Shift along the demand curve, quantity demanded decreases
Demand
Quantity of goods and services the consumer is willing and able to pay at various prices per period time, ceteris paribus
Supply
The quantity of goods and services the producer is willing and able to supply at various price per period time, ceteris paribus
Cost of raw material falls
Decrease in cop
Increase in potential profits
- increase supply, supply shift right
Alternative products become more profitable
Change in expected price of goods
Other products is more profitable
- Decrease in supply of good
Related goods
Affecting supply 1. competitive supply 2. Joint supply Affecting demand 1. Complement 2. Substitutes
Substitutes
Good that fulfill the same needs and wants
Complements
Goods that are consumed together to perform the same purpose
Competitive supply
Two goods are produced from the same resources, such that the resources used in one good cannot be used to produce the other good
Joint supply
2 goods are produced jointly by the same resources
Derived demand
The demand of good is dependent on the demand of the good that uses it(fop)
