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Price Mechanism Econ

The document discusses how the price mechanism reallocates resources when there is a change in supply or demand. It explains the signaling, incentive, and rationing functions of prices and how prices adjust to clear the market through an example of a decrease in supply, causing a shortage. The shortage leads to rising prices which signal the issue and incentivize producers to increase supply and consumers to reduce demand, clearing the market at a new equilibrium price.

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11 views

Price Mechanism Econ

The document discusses how the price mechanism reallocates resources when there is a change in supply or demand. It explains the signaling, incentive, and rationing functions of prices and how prices adjust to clear the market through an example of a decrease in supply, causing a shortage. The shortage leads to rising prices which signal the issue and incentivize producers to increase supply and consumers to reduce demand, clearing the market at a new equilibrium price.

Uploaded by

seven.chen.2026
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Add-Class for 11/5

Sunday, November 5, 2023 11:07 AM

Describe how price mechanism reallocate resource when here is a change in D/S

Price mechanism: Prices determined by the forces of supply and demand in competitive markets.

3 Uses of Price:
Signaling function of price:
Price communicate information to decision makers.
When the price increase, it gives the signal to supplier that there is a product shortage

Incentive function of price:


Price motivate decision makers to respond to the information and make the best decisions for themselves
When price goes up, it is an incentive for existing suppliers to produce more and potential suppliers to enter the market,
and it's also an incentive for buyers to buy less, vice versa.

Rationing function of price:


Rationing is a method of apportioning or parceling out goods and services among consumers or households
Whether or not a consumer will get a good is determined by the price of that good only.

Describe how price mechanism reallocate resource when there is a decrease in Supply (10)
Definition:
Price mechanism & Supply

Diagram:

Explanation: Explanation:
While supply decreases from S to S1, at Price Pe, quantity will fall from Qe to Q2. Quantity demanded is While supply increases from S1 to S2, quantity supplied will increase from Qe to Q1. Quantity demanded
still at original equilibrium quantity Qe. There will be a shortage (Qe>Q2). The shortage will lead market is still at original equilibrium quantity Qe. There will be surplus (Q1>Qe). The surplus will lead market
price of the product to start to rise. price of the product to start to decrease.

Rise in price will inform all the consumers and producers that there is a shortage in the market. The Decrease in price will inform all the consumers and producers that there is a surplus in the market. The
decision makers will then response to the rise in price. That is the signaling function of price mechanism. decision makers will then response to the decrease in price. That's the signaling function of price
Rise in price will also provide incentives for consumers and producers to change their behavior. Higher mechanism. Rise in price will also provide incentives for consumer and producers to change their
prices will increase profits of firms and provide them incentive to increase quantity supplied. Higher behavior. Lower prices will decrease profits of firms and provide them incentive to decrease the
prices will also incentivize consumers to reduce their quantity demanded. That is the incentive function quantity supplied. Meanwhile, lower prices will also incentivize consumer to increase their quantity
of price mechanism. Quantity supplied will increase and quantity demanded will fall as price rises. Qd & demanded. That is the incentive function of price mechanism. Quantity supplied will decrease and
Qs will meet again at quantity Q1 when price rises from Pe to P1. The market is cleared again at new quantity demanded will increase as price falls. Qd &Qs will meet again at the Q2 when price falls from
market equilibrium with rises in price, that is rationing function mechanism. Pe to P1. The market is cleared again at market equilibrium with decrease in price, that is rationing
function of price mechanism.

IB Econ Page 1

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