AS MicroThe Price Mechanism

in Action

Functions of the Price Mechanism

1. Allocate – the market mechanism allocates scarce resources

2. Ration – prices serve to ration scarce resources when demand outstrips supply

3. Signal – market prices adjust to demonstrate where resources are required, and where they are not.

4. Incentive – when the price of a product rises, the quantity supplied increased, this is due to the incentive function

Diagrams matter!

Diagram must havesFully labeledOriginal and new equilibriumDemand and supply the correct way round Well explained – you must explain why the

curve has shifted, in detailThink about the elasticity – e.g. oil has

inelastic demand and supply

Shift Equilibrium Price

Demand increases Higher

Demand decreases Lower

Supply increases Lower

Supply decreases Higher

Shift Equilibrium Price Equilibrium Quantity

Demand increases Higher Higher

Demand decreases Lower Lower

Supply increases Lower Higher

Supply decreases Higher Lower

Which direction?

Market Change Shift in Supply or Demand?

Rise or Fall in Market Price for

Crude Oil?A deep recession in many of the world’s advanced economiesOPEC decides to introduce lower output quotas for each of their members

Which direction?

Market Change Shift in Supply or Demand?

Rise or Fall in Market Price for

Crude Oil?A deep recession in many of the world’s advanced economies

DEMAND

OPEC decides to introduce lower output quotas for each of their members

Using an analysis diagramPrice

Quantity of crude oil

D1

S1

P1

Q1

Using an analysis diagramPrice

Quantity of crude oil

D1

S1

P1

Q1

D2

Using an analysis diagramPrice

Quantity of crude oil

D1

S1

P1

Q1

D2

P2

Q2

Which direction?

Market Change Shift in Supply or Demand?

Rise or Fall in Market Price for

Crude Oil?A deep recession in many of the world’s advanced economies

DEMAND

OPEC decides to introduce lower output quotas for each of their members

SUPPLY

Using an analysis diagramPrice

Quantity of crude oil

D1

S1

P1

Q1

Using an analysis diagramPrice

Quantity of crude oil

D1

S1

P1

Q1

S2

Using an analysis diagramPrice

Quantity of crude oil

D1

S1

P1

Q1

S2

Q2

P2

The effects of high oil prices

P6

StakeholdersGroups who benefit from high oil prices

Groups who lose out from high oil prices

Oil companies themselves

Industries supplying petroleum businesses

Oil exporting nations

Government – oil taxes

Renewable energy industry

StakeholdersGroups who benefit from high oil prices

Groups who lose out from high oil prices

Oil companies themselves Consumers of products that uses oil as essential input

Industries supplying petroleum businesses

Transport businesses e.g. airlines, road haulage

Oil exporting nations Consumer goods businesses (less real income to spend)

Government – oil taxes

Renewable energy industry

The Global Market for Aluminium

Shifts in supply & demandMarket Change Shift in Supply

or Demand?Rise or Fall in Market Price for Aluminium?

A fall in demand for new long-haul aircraft

Tighter fuel-efficiency standards for new vehicles in the USA

A persistent fall in the world price of steel

A rise in the price of bauxite (used in manufacturing aluminium)

Shifts in supply & demandMarket Change Shift in Supply

or Demand?Rise or Fall in Market Price for Aluminium?

A fall in demand for new long-haul aircraft

DEMAND FALL

Tighter fuel-efficiency standards for new vehicles in the USA

A persistent fall in the world price of steel

A rise in the price of bauxite (used in manufacturing aluminium)

Shifts in supply & demandMarket Change Shift in Supply

or Demand?Rise or Fall in Market Price for Aluminium?

A fall in demand for new long-haul aircraft

DEMAND FALL

Tighter fuel-efficiency standards for new vehicles in the USA

DEMAND RISE

A persistent fall in the world price of steel

A rise in the price of bauxite (used in manufacturing aluminium)

Shifts in supply & demandMarket Change Shift in Supply

or Demand?Rise or Fall in Market Price for Aluminium?

A fall in demand for new long-haul aircraft

DEMAND FALL

Tighter fuel-efficiency standards for new vehicles in the USA

DEMAND RISE

A persistent fall in the world price of steel

DEMAND FALL

A rise in the price of bauxite (used in manufacturing aluminium)

Shifts in supply & demandMarket Change Shift in Supply

or Demand?Rise or Fall in Market Price for Aluminium?

A fall in demand for new long-haul aircraft

DEMAND FALL

Tighter fuel-efficiency standards for new vehicles in the USA

DEMAND RISE

A persistent fall in the world price of steel

DEMAND FALL

A rise in the price of bauxite (used in manufacturing aluminium)

SUPPLY RISE

Shifts in supply & demandA fall in demand for new long-haul aircraft

DEMAND FALL

Price of Aluminium

Demand

Supply

P1

Q1 Quantity of Aluminium

Shifts in supply & demandA fall in demand for new long-haul aircraft

DEMAND FALL

Price of Aluminium

Demand

Supply

P1

Q1 Quantity of Aluminium

D2

Shifts in supply & demandA fall in demand for new long-haul aircraft

DEMAND FALL

Price of Aluminium

Demand

Supply

P1

Q1 Quantity of Aluminium

D2

P2

Q2

Shifts in supply & demand

Price of Aluminium

Demand

Supply

P1

Q1 Quantity of Aluminium

D2

P2

Q2

A rise in the price of bauxite (used in manufacturing aluminium)

SUPPLY RISE

S2

Shifts in supply & demand

Price of Aluminium

Demand

Supply

P1

Q1 Quantity of Aluminium

D2

P2

Q2

A rise in the price of bauxite (used in manufacturing aluminium)

SUPPLY RISE

S2

P3

Q3

Price of Aluminium

D1

S1

P1

Q1Quantity of Aluminium

Price of Pepsi Max

Di

Si

Pi

QiQuantity of Pepsi Max

Inter-related markets

Price of Aluminium

D1

S1

P1

Q1Quantity of Aluminium

Price of Pepsi Max

Di

Si

Pi

QiQuantity of Pepsi Max

Inter-related markets

D2

P2

Q2

Price of Aluminium

D1

S1

P1

Q1Quantity of Aluminium

Price of Pepsi Max

Di

Si

Pi

Qi Quantity of Pepsi Max

Inter-related markets

D2

P2

Q2

Sii

Pii

Qii

Analysis

Evaluation

Application

Good application opens the door to good analysis and good evaluation

Why are prices volatile in the markets for many commodities?

Using analysis diagramsPrice

Quantity

Price

Quantity

S1

D1 D2

P1

P2

Using analysis diagramsPrice

Quantity

Price

Quantity

S1

D1 D2

P1

P2S1

D1

Using analysis diagramsPrice

Quantity

Price

Quantity

S1

D1 D2

P1

P2S1

D1

S2

P1

P2

RISE IN MARKET SUPPLYRISE IN MARKET DEMAND

Problems arising from price volatility