2.3 Competitive Market Equilibrium (DP IB Economics: HL): Flashcards
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Define a market.
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Define a market.
A market is any place that brings buyers and sellers together to trade at an agreed price, and can be physical or virtual.
Define the equilibrium price.
The equilibrium price, or market-clearing price, is the price at which demand equals supply and sellers clear their stock at an acceptable rate.
When does market equilibrium occur?
Market equilibrium occurs when demand equals supply, at the market-clearing price and quantity.
Define excess demand.
Excess demand occurs when demand is greater than supply, creating a shortage, and arises when the price is too low.
Excess demand (a shortage) arises when the price is the equilibrium price.
Excess demand (a shortage) arises when the price is below the equilibrium price.
Define excess supply.
Excess supply occurs when supply is greater than demand, creating a surplus, and arises when the price is too high.
Excess supply (a surplus) arises when the price is the equilibrium price.
Excess supply (a surplus) arises when the price is above the equilibrium price.
How does a market clear excess demand?
Sellers raise prices, causing a contraction in quantity demanded and an extension in quantity supplied until equilibrium is restored.
How does a market clear excess supply?
Sellers lower prices, causing an extension in quantity demanded and a contraction in quantity supplied until equilibrium is restored.
True or False?
Excess demand is also known as a surplus.
False.
Excess demand is a shortage; a surplus is caused by excess supply.
True or False?
A buyer who refuses to purchase a good at its price is exercising consumer sovereignty.
True.
By choosing not to buy, buyers exercise their consumer sovereignty, signalling that they do not agree with the price.
What are the two forms of market disequilibrium?
The two forms of disequilibrium are excess demand (a shortage) and excess supply (a surplus).
Define the price mechanism.
The price mechanism is the interaction of demand and supply in a free market, which determines prices and allocates scarce resources between competing wants.
What did Adam Smith call the workings of the price mechanism?
Adam Smith referred to the functions of the price mechanism as the 'invisible hand'.
What are the two functions of the price mechanism?
The two functions of the price mechanism are resource allocation (through signalling and incentives) and rationing.
Define the signalling function of prices.
The signalling function is where prices provide information to producers and consumers about where resources are wanted and where they are not.
Define the incentive function of prices.
The incentive function is where rising prices encourage producers to reallocate resources into a market to maximise profits, and falling prices encourage reallocation away from it.
Define the rationing function of prices.
The rationing function is where prices ration scarce resources, so that as resources become scarcer the price rises and only those who can afford them receive them.
The price mechanism is the interaction of demand and in a free market.
The price mechanism is the interaction of demand and supply in a free market.
True or False?
A shift in demand or supply sends a signal, whereas a movement along a curve reflects the incentive function.
True.
A shift in a curve is the market signalling to consumers and producers, while a movement along a curve results from the incentive function.
When resources become scarcer, their price will so that only those who can afford them receive them.
When resources become scarcer, their price will rise so that only those who can afford them receive them.
In which types of market does the price mechanism operate?
The price mechanism operates in all markets, including local, national and global markets.
True or False?
The functions of the price mechanism are built on the principle of self-interest.
True.
Each party acts in their own self-interest, which drives both the incentive and rationing functions.
How does a rising price ration a scarce good?
A rising price rations a scarce good because only those consumers who can afford to pay the higher price receive it.
Define consumer surplus.
Consumer surplus is the difference between the amount a consumer is willing to pay for a product and the price they actually pay.
Define producer surplus.
Producer surplus is the difference between the amount a producer is willing to sell a product for and the price they actually receive.
Define social (community) surplus.
Social (community) surplus is the sum of consumer surplus and producer surplus in a market.
Where is consumer surplus shown on a market diagram?
Consumer surplus is the area beneath the demand curve and above the equilibrium price.
Where is producer surplus shown on a market diagram?
Producer surplus is the area above the supply curve and below the equilibrium price.
True or False?
Consumer and producer surplus are maximised when the market is in equilibrium.
True.
At equilibrium both surpluses are maximised, and any disequilibrium reduces social surplus.
Any disequilibrium in a market the social surplus.
Any disequilibrium in a market reduces the social surplus.
What happens to consumer and producer surplus when supply increases?
Both consumer surplus and producer surplus increase as a result of the increase in supply.
What happens to consumer and producer surplus when demand increases?
Both consumer surplus and producer surplus increase as a result of the increase in demand.
How is consumer or producer surplus calculated from a diagram?
It is calculated as the area of a triangle, using the formula (base x height) / 2.
Define allocative efficiency.
Allocative efficiency occurs at the output where marginal benefit equals marginal cost (MB = MC), so consumers and producers gain the maximum possible benefit.
A market is allocatively efficient at the output where marginal benefit equals .
A market is allocatively efficient at the output where marginal benefit equals marginal cost.
Define productive efficiency.
Productive efficiency occurs at the level of output where average costs are minimised, with no wastage of scarce resources.
True or False?
Allocative efficiency occurs where average costs are minimised.
False.
That describes productive efficiency; allocative efficiency occurs where marginal benefit equals marginal cost (MB = MC).
In an allocative efficiency diagram, what does the demand curve represent?
The demand curve represents the marginal benefit (MB) to the consumer, while the supply curve represents marginal cost.
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