2.3 Competitive Market Equilibrium (DP IB Economics: SL): Flashcards
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Define market equilibrium.
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Define market equilibrium.
Market equilibrium occurs when demand equals supply, giving an equilibrium price and quantity that works for both buyers and sellers.
What is another name for the equilibrium price?
The equilibrium price is also known as the market-clearing price.
True or False?
A surplus arises when the market price is below the equilibrium price.
False.
A surplus (excess supply) arises when price is above equilibrium; a shortage arises when price is below equilibrium.
Define excess demand.
Excess demand occurs when demand is greater than supply, creating a shortage in the market.
Excess demand can occur when prices are too or when demand is so high that supply cannot keep up.
Excess demand can occur when prices are too low or when demand is so high that supply cannot keep up.
How do sellers respond to clear a market with excess demand?
Sellers gradually raise prices, causing a contraction in quantity demanded and an extension in quantity supplied until equilibrium is restored.
Define excess supply.
Excess supply occurs when supply is greater than demand, creating a surplus in the market.
How do sellers respond to clear a market with excess supply?
Sellers gradually lower prices, causing a contraction in quantity supplied and an extension in quantity demanded until equilibrium is restored.
When sellers lower prices to clear excess supply, buyers respond with an in quantity demanded.
When sellers lower prices to clear excess supply, buyers respond with an extension in quantity demanded.
Define market.
A market is any place that brings buyers and sellers together to trade at an agreed price.
What are the two types of market by location?
Markets can be physical (e.g. McDonald's) or virtual (e.g. eBay).
True or False?
Every market takes the same length of time to return to equilibrium.
False.
Different markets take different lengths of time; retail clothing may clear in a few days whereas the housing market may take months or years.
Define price mechanism.
The price mechanism is the interaction of demand and supply in a free market that determines prices and allocates scarce resources between competing wants and needs.
What did Adam Smith call the functions of the price mechanism?
Adam Smith referred to the functions of the price mechanism as the 'mystery of the invisible hand'.
Define the signalling function.
The signalling function is when prices provide information to producers and consumers about where resources are wanted and where they are not.
Define the incentive function.
The incentive function is when rising prices encourage producers to reallocate resources to more profitable markets in order to maximise their profits.
True or False?
The price mechanism allocates resources through central planning by the government.
False.
The price mechanism allocates resources through the interaction of demand and supply in a free market.
Define the rationing function.
The rationing function is when prices ration scarce resources, so that only those who can afford to pay receive them.
When resources become scarcer, the price will further, so only those who can afford them receive them.
When resources become scarcer, the price will rise further, so only those who can afford them receive them.
What are the two functions the price mechanism fulfils?
The price mechanism fulfils the functions of resource allocation and rationing.
In the Long Island honey market, what happened to the price when demand for honey increased?
When demand for honey increased, the price rose from $15 to $18.
In 2018, the supply of T-shirts in the UK increased because the price of fell.
In 2018, the supply of T-shirts in the UK increased because the price of cotton fell.
True or False?
A movement along a curve reflects the signalling function of the price mechanism.
False.
A movement along a curve reflects the incentive function; a shift of a curve reflects the signalling function.
The functions of the price mechanism are built on which principle?
The functions of the price mechanism are built on the principle of self-interest.
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.
Where does consumer surplus lie in relation to the demand curve?
Consumer surplus lies underneath the demand curve, above the equilibrium price.
Define producer surplus.
Producer surplus is the difference between the price a producer actually receives for a product and the amount they were willing to sell it for.
Producer surplus lies the supply curve, between the supply curve and the equilibrium price.
Producer surplus lies above the supply curve, between the supply curve and the equilibrium price.
Define social (community) surplus.
Social (community) surplus is the sum of consumer surplus and producer surplus.
True or False?
An increase in supply reduces consumer surplus.
False.
An increase in supply raises consumer surplus; both consumer and producer surplus increase as a result.
When are consumer and producer surplus maximised?
Consumer and producer surplus are maximised when the market is at equilibrium.
Define allocative efficiency.
Allocative efficiency occurs at the level of output where marginal benefit equals marginal cost (MB = MC), so no one can be made better off without making someone else worse off.
The demand curve represents the marginal (MB) to the consumer.
The demand curve represents the marginal benefit (MB) to the consumer.
What formula is used to calculate consumer or producer surplus from a diagram?
Consumer or producer surplus is found using the area of a triangle, (b × h) ÷ 2.
True or False?
Productive efficiency occurs at the output where marginal benefit equals marginal cost.
False.
That describes allocative efficiency; productive efficiency occurs where average costs are minimised.
How does an increase in demand affect consumer and producer surplus?
An increase in demand causes both consumer and producer surplus to increase.
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