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Table of Contents

  1. Topic pack - Microeconomics - introduction
  2. 1.1 Competitive Markets: Demand and Supply
  3. 1.1 Competitive Markets: Demand and Supply - notes
    1. The nature of markets
    2. Types of markets
    3. Market structure
    4. Spectrum of competition
    5. Demand
    6. The law of demand
    7. Individual and market demand
    8. Non-price determinants of demand
    9. Movements along the demand curve
    10. Shifts in the demand curve
    11. Example - shifts and movements along a demand curve
    12. Exceptions to the normal law of demand
    13. Linear demand functions
    14. Linear demand functions - example
    15. The law of supply
    16. Non-price determinants of supply
    17. Movements along the supply curve
    18. Shifts in the supply curve
    19. Shifts and moves of supply curve
    20. The real supply curve?
    21. Linear supply functions
    22. Linear supply functions - example
    23. Market equilibrium
    24. Market equilibrium - notes
    25. Excess demand and excess supply
    26. Example 1 - the market for DVD players
    27. Example 2 - the market for fish
    28. Applications of demand and supply
    29. Calculating market equilibrium
    30. Calculating equilibrium - example
    31. Scarcity and choice
    32. Choice and opportunity cost
    33. Price signalling
    34. Market efficiency - consumer surplus
    35. Market efficiency - producer surplus
    36. Allocative efficiency
  4. 1.1 Competitive markets - questions
  5. 1.1 Competitive markets - simulations and activities
  6. 1.2 Elasticities
  7. 1.2 Elasticities - notes
  8. Section 1.2 Elasticities - questions
  9. Section 1.2 Elasticities - simulations and activities
  10. 1.3 Government intervention
  11. 1.3 Government Intervention - notes
  12. 1.3 Government intervention - questions
  13. 1.3 Government intervention - simulations and activities
  14. 1.4 Market failure
  15. 1.4 Market failure - notes
  16. Section 1.4 Market failure - questions
  17. Section 1.4 Market failure - simulations and activities
  18. 1.5 Theory of the firm
  19. 1.5 Theory of the firm - notes (HL only)
  20. Section 1.5 Theory of the firm - questions
  21. Section 1.5 Theory of the firm - simulations and activities
  22. Print View

Price signalling

Syllabus: Explain, using diagrams, that price has a signalling function and an incentive function, which result in a reallocation of resources when prices change as a result of a change in demand or supply conditions.

Resource allocation - the importance of price as a signal

S:\TripleA\Design\icons\small\key_terms.gif Price Signalling function - you can use ESEPME to answer questions on price signalling to producers (the role of price in resource allocation)

In a market economy, prices perform a signalling function - prices adjust to show where resources are required (price increase) and where they are not (price decrease)

S:\TripleA\Design\icons\small\key_terms.gif Price Incentive function - ESEPME again but this time effect of price changes on consumers (demand)

Prices also perform an incentive function. As prices rise or fall, this provides an incentive for consumers to purchase less/more (as the price to benefit ratio) falls/rises).

How to define an economy

S:\triplea_resources\DP_topic_packs\economics\student_topic_packs\media_microeconomics\images\dollar_symbol.jpgThe central problem of economics is one of scarcity of productive resources relative to the unlimited potential demand that could be made upon them. It therefore follows that every society, be it centrally planned or based upon markets, has to have some mechanism (system) by which its resources, that is its land, labour and capital, are allocated amongst all the numerous uses to which they could be put.

Definition: An economy is a set of systems to allocate scarce resource

cf. Free Market economy
(allocation by the market - price - mechanism)
economy (Centrally Planned Economy - allocation by the state - Socialism)
Mixed economy
(both price mechanism and state allocations side by side)

So, by what process are resources deployed so as to ensure that consumers obtain exactly the right amounts of frying pans, ice creams, jeans etc. that they require? Well, under a system of central planning the answer is not too difficult to ascertain - the state planning authority decides upon its priorities and directs resources to those lines of production which are deemed to be most important;

but, in the free market how do consumers magically obtain those goods that they want in just the right quantities? Here the answer is slightly less obvious - essentially, it is through the interaction of demand and supply. How exactly does this interaction perform the allocative function? Yes - ESEPME - did I mention how important it is to know, remember and understand this process in detail?

The short answer to the above question is that it is through changes in prices. These changes in price indicate and motivate - this is called the signalling and incentive functions. Changes in price indicate the relative strength of consumer demand and signal to producers the changes in demand for their goods or services. Prices also indicate changes in supply that enable producers to signal to consumers what is available on the market and on what terms. Rising prices of goods motivate producers to respond to increases in demand by increasing supply; producers will decrease supply when prices fall because of, ceteris paribus, the effects on profit. You see more clearly how this works when you see how the market forces of supply and demand interact to determine price (ESEPME).