You owe

1
You owe

• Green sheet rhubarb custard Ec quiz

2
Price Mechanism
D S issues
3
Aims of the syllabus

• Understand the rationing, incentive and
  signalling functions of the price mechanism for
  allocating scarce resources.
• Review development of consumer producer
  surplus.

4
Role of markets

• So far we have focused on consumer markets,
  however, from one of our first lessons we looked
  at the range of markets.
• Your exam board tend to expect you to raise your
  horizons to more sophisticated markets
• Agricultural markets
• Housing markets
• Labour markets
• Currency markets
• Commodity markets

5
Adam Smith - The moral philosopher and political
economist (1723-1790)

• He provided a strong argument for a free market
  in which the invisible hand of the market would
  allocate resources to everyones advantage.
• He identified THREE agents within a market
  system
• Consumers
• Producers
• Owners of FoPs

6
Consumers
In a free market
7
Consumers

• Consumers are free to spend their money as they
  wish (in a free market)
• They demand a wide range of goods to satisfy
  their needs wants
• Utility, welfare satisfaction play a role here.
• If a consumer really wants a product, then they
  are free to pay above the market price, i.e.
  consumer surplus.

8
Consumer Surplus.

• Consumer surplus measures the welfare that
  consumers derive from their consumption of goods
  and services, or the benefits they derive from
  the exchange of goods. 
• Consumer surplus is the difference between what
  consumers are willing to pay for a good or
  service (indicated by the position of the demand
  curve) and what they actually pay (the market
  price). 

9
Producers
In a free market
10
Producers in a free market

• They are the slaves of the consumers!
• Motivated by high profits
• Aim to maximise difference between revenues
  costs
• High revenues producing what the consumers want
• Low costs minimise costs so that they can
  either sell at a lower price or gain high profit
  margins!

11
Producer surplus

• It is the difference between what producers are
  willing and able to supply a good for and the
  price they actually receive.
• The level of producer surplus is shown by the
  area above the supply curve and below the market
  price

12
Owners of FoPs
In a free market
13
Owners of FoPs
All want the highest return possible on their
assets
Capital
Labour
Enterprise
Land
14
Function of Prices
In a free market
15
The 3 Functions of Price

• Rationing
• Signalling
• Incentive

16
Rationing

• If there are scarce resources, then they need to
  be rationed between the consumers infinite wants.
• Draw an elastic Demand curve
• Draw an inelastic Supply curve
• What would happen under the market mechanism if
  they was a fall in supply?
• What has happened along the Demand curve?
• How does this link to income effect
  substitution effect?

17
Signalling

• The price of a good sends clear signals to both
  consumers and producers
• If the price is set below the market
  equilibrium.
• Draw this on a D S diagram.
• What happens to D S?
• WHY does this happen?

18
Incentive

• Low price tag encourages consumers to buy more
  it increases your utility or amount of
  satisfaction.
• Higher prices discourage consumers from buying
  due to income effect.
• Low prices discourage production
• A long fall in prices will drive some firms out
  of the marker.
• High prices encourage firms to supply more, take
  on more workers invest in new technology.

19
Exceptions to the laws of demand

• When an increase in price acts encourages demand!

20
Price mechanism in action gold!

• The high price of gold is giving a clear signal
  to a mining company in the Highlands of Scotland
  that it should start production from a gold mine
  that was first drilled 20 years ago, but has
  never been commercially worked because the price
  of gold did not provide enough incentive to the
  producers.
• However with the price of gold now at 1100 per
  ounce, mining operations could become profitable.
  
• Scotgold owns the Coronish mine near Tyndrum, a
  small village which is en route to Glen Coe, Fort
  William and Skye.
• Cononish is expected to start producing 200kg of
  gold a year at the mine site when full-scale
  mining begins in 2011 enough to produce 30,000
  wedding rings a year and another 500kg each
  year by sending rocks for processing elsewhere.

21
(No Transcript)
22
AS Multi choice practice

• Complete your answers on BACK of sheet.
• Choose option explain
• (define, formula / calculate, explain)

23
Your HWK task.

• Read chapter 15 in textbook
• Complete p 99 Q 2
• Flat screen TVs

24
AS Multi choice practice

• Complete your answers on BACK of sheet.
• Choose option explain
• (define, formula / calculate, explain)

25
1.
26
AnswerB (1)

• Explanation of how prices ration scarce goods
  interaction of supply and demand (2)
• Supply and demand diagram to show equilibrium
  price (1) plus
• a further mark (1) for showing a change in
  equilibrium price (2)
• Correct identification of other features of free
  market economy, e.g., private ownership of
  resources - up to 2 marks (2)
• Also allow credit for
• Definition of price mechanism (1)
• Definition of scarcity (1)

27
2.
28
AnswerA (1)

• Definition of income elasticity of demand (2)
• Correct numerical calculation (2)
• Potatoes are an inferior good (1)
• A rise in incomes will cause a fall in demand (1)
  

29
3.
30
AnswerC (1)

• Define consumer surplus (2 marks) or description
  of the area between demand curve and price (1
  mark).
• Maximum of 2 marks can be awarded here.
• Diagram or written explanation that consumer
  surplus falls when the supply curve shifts to the
  left caused by a rise in the costs of
  production (2 marks).

31
4.
32
Answer B (1)

• Explanation that increase in demand for rugby
  balls causes publicity participation generates
  a shift in demand from D1 to D2 (1 mark).
• Explanation that fall in costs will result in
  shift of the supply curve from S1 to S2 (1 mark)
• With signals to generate more profit (1 mark).
• Annotation of diagram (1 mark)