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What happens to the market price when there is a shortage?
What happens to the market price when there is a shortage?
The price mechanism ensures divergence from equilibrium.
The price mechanism ensures divergence from equilibrium.
False
What is the name of the function that occurs when a price rise brought about by an increase in demand provides an incentive for firms to shift resources?
What is the name of the function that occurs when a price rise brought about by an increase in demand provides an incentive for firms to shift resources?
The incentive function
The price mechanism performs a _______________ function as the available supply is rationed out by price.
The price mechanism performs a _______________ function as the available supply is rationed out by price.
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What happens to society's welfare when there is a price control?
What happens to society's welfare when there is a price control?
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The equilibrium price changes only if there has been a change in a condition of demand or supply.
The equilibrium price changes only if there has been a change in a condition of demand or supply.
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Products whose conditions of demand and supply are inherently _______________ are subject to greater price fluctuations.
Products whose conditions of demand and supply are inherently _______________ are subject to greater price fluctuations.
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What is the term for the net loss in society's welfare that occurs when there is a price control?
What is the term for the net loss in society's welfare that occurs when there is a price control?
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What is the function of the price mechanism that signals to suppliers to produce more of a product?
What is the function of the price mechanism that signals to suppliers to produce more of a product?
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Match the following functions of the price mechanism with their descriptions:
Match the following functions of the price mechanism with their descriptions:
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Study Notes
Demand
- Demand is the amount of a good or service consumers are willing and financially able to buy at a given price during a period of time.
- Effective demand is when wants are backed up by the financial ability to buy.
- The law of demand states that if other things do not change, the quantity demanded of a commodity will be smaller at higher market prices and larger at lower market prices.
- Utility is the satisfaction people get from consuming or using a good or service.
- The law of diminishing marginal utility states that the extra units consumed of any good or service usually yield less and less additional utility.
Individual Demand Curve and Market Demand Curve
- An individual's demand is one buyer's demand for a good.
- Market demand is the total amount demanded by each consumer at that price.
- A market demand curve is the horizontal summation of all individual demand curves.
- It shows the amount of a good demanded at different prices during a specific period of time.
Movements along the Demand Curve and Shifts in the Demand Curve
- Movement along the demand curve occurs when the price changes and there is no change in other factors influencing demand (ceteris paribus).
- A change in the product's own price (caused by a change in supply) never shifts the demand curve for that good.
- If something other than price changes (so that the ceteris paribus condition is violated), then there is a change in demand and the demand curve shifts.
Factors Influencing Demand
- Real disposable income of consumers
- Price of substitutes or goods in competitive demand
- Price of complements or goods in joint demand
- Consumer tastes and fashion
- Advertising
- Expectations about the economy
- Population size and structure
- Religious beliefs
Exceptional Demand Curves
- Veblen goods: demand increases as price rises due to conspicuous consumption.
- Goods with uncertain product quality: demand increases as price rises due to consumer ignorance.
- Giffen goods: demand increases as price rises, often due to subsistence economies and basic necessities.
Consumer Surplus
- Consumer surplus is the difference between the maximum a consumer would pay for a good and the price actually paid.
- It is shown by the area above the price line and below the demand curve.
Supply
- Supply is the amount of a good that producers in an industry are both willing and able to sell at a given price during a period of time.
Individual Supply and Market Supply
- An individual supply curve shows the quantity that one firm is willing and able to sell at different prices.
- A market supply curve is the total amount that will be supplied by all firms in the industry at different prices during a period of time.
Movements along the Supply Curve and Shifts in the Supply Curve
- Movement along the supply curve occurs when the price changes and there is no change in other factors influencing supply (ceteris paribus).
- A change in the price of a good never shifts the supply curve for that good.
- If something other than price changes (so that the ceteris paribus condition is violated), then there is a change in supply and the supply curve shifts.
Factors Influencing Supply
- Price of factor inputs or factors of production
- Price of other goods (competitive supply or joint supply)
- Government taxes and subsidies on the firm
- State of technology
- Expectations of future price changes
- Weather or unforeseen circumstances
- Number of firms in the industry
Producers' Surplus
- Producers' surplus is the difference between the minimum price a producer would accept to supply a given quantity of a good and the price actually received.
Determination of Market Price
- In a free or uncontrolled market, prices are determined by the interaction of demand and supply.
- The market equilibrium price is the price at which there is no reason for anything to change unless disturbed by an outside shock.
Changes in Market Equilibrium Price
- Changes in market equilibrium price must be due to changes in demand or supply, or both.
- Changes in demand or supply can cause changes in the market equilibrium price.
Importance of Ceteris Paribus Condition
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The 'ceteris paribus' condition is a Latin term that means 'all other things remaining the same'.
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It is important to remember that the effect of a change in price depends on the cause.### Ceteris Paribus
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Ceteris paribus allows us to isolate the factor of interest and investigate its impact on another variable by holding all other relevant factors constant.
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It enables us to understand the effect of a change in one factor on the dependent variable, assuming all other factors remain constant.
Economic Theory and Experiments
- In laboratory sciences, experiments are conducted to hold all other relevant factors constant, except for the one under investigation.
- In economics, it's difficult to isolate the effect of a single factor as multiple factors vary simultaneously.
Conclusions
- Changes in demand or supply conditions push the system into disequilibrium, leading to changes in equilibrium prices.
- The market price is automatically moved towards equilibrium by forces at work.
- Products with unstable demand and supply conditions are subject to greater price fluctuations.
- The effect of a rise in price on equilibrium output depends on the cause.
The Price Mechanism
- The price mechanism responds to shortages and surpluses, causing prices to rise or fall.
- The price mechanism ensures convergence towards equilibrium.
- An efficient price mechanism fulfills three functions:
Signalling Function
- A rise in price signals suppliers to produce more of the product.
Incentive Function
- A price rise provides an incentive for firms to reallocate resources and increase production.
Rationing Function
- The price mechanism rations out the available supply as the price rises.
Society's Welfare
- At the market equilibrium price, society's welfare (the summation of consumers' and producers' surpluses) is at its greatest.
- Price control results in an unequal shift of surplus from one group to another, leading to a deadweight loss in society's welfare.
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Description
This quiz is about the concept of demand in economics. It explains the law of demand and its relation to effective demand and ability to pay.