Price determination via the market mechanism content slideshow. Designed for the Economic A level qualification. Can be used in revision and in class. Subtopics: The Price Market Mechanism & Market Equilibrium The Impact of changes in Demand & Supply on Equilibrium The Functions of the Price Mechanism The Effectiveness of Markets in Allocating Resources

1. Price
Determination
via the Price
Market
Mechanism
Lower 6th Micro
How Markets Work

2. The Price Market
Mechanism &
Market
Equilibrium
Price Determination via the Price Market
Mechanism
Mr O’Grady

3. The Price Market Mechanism & Market Equilibrium
Price Market Mechanism: the means by which millions of decisions taken by consumers
and businesses interact to determine the allocation of scarce resources between
competing uses
It uses the market forces of supply and demand to determine the equilibrium price and quantity of a
good or service.
Market Equilibrium: the point at which demand is equal to supply.
Market Clearing Price: the price that is charged at market equilibrium, so called as all
products made will be sold at this price
All buyers can get the exact amount that they want to buy at this price
All sellers provide exactly the amount that they want to sell at this price
therefore, there is nothing left over – the market has cleared
Changes to equilibrium: Any change in demand and/or supply will lead to a new
equilibrium price
Showing Market equilibrium graphically:
Price
Quantity
D
P
Q
S
At a price of P quantity demanded (Qd) is equal to quantity
supplied (Qs). All products are sold and no products are left over –
the market has cleared.
At this price all products that have been offered for sale by
suppliers have been bought by buyers all supply has had an equal
demand.

4. Market Forces
Excess Supply: If price were to rise to P1 we
would have a position of excess supply.
Buyers would demand less (Q1) at the higher price
but firms would wish to supply more (Q2) at this
price. This would lead to a situation of too much
supply (Q2 – Q1) in the market.
Solution: firms would need to lower price to get rid
of excess products. Pushing Q1 up and Q2 down,
forcing towards each other (market equilibrium)
Excess Demand: If price were to fall to P2 we
would have a position of excess demand.
Buyers would demand more (Q2) at the lower price
but firms would wish to supply less (Q1) at this
price. This would lead to a situation of too much
demand (Q2 – Q1) in the market.
Solution: To improve profitability firms could raise
price, thus reducing the excess demand. Pushing Q1
up and Q2 down, forcing them towards each other
(market equilibrium)
Price
Quantity
D
P
Q
S
P1
Q2Q1
Price
Quantity
D
P
Q
S
P2
Q2Q1

5. The Impact of
changes in
Demand & Supply
on Equilibrium
Price Determination via the Price Market
Mechanism
Mr O’Grady

6. The Impact of changes in Demand & Supply on Equilibrium
Recap: A change in price corresponds to a movement along either the demand or
supply curve, a change to any other factor will cause a shift in either demand or
supply,
Example changes which cause shifts in the demand curve:
Consumer income
Prices of other goods and services
Consumer tastes and fashion
Other factors e.g. advertising
Example changes which cause shifts in the supply curve:
The impact of changing costs of production
Technological progress
Prices of other goods and services
Government policy e.g. taxes and subsidies
Other factors e.g. expectations
A new equilibrium price: When there is a new equilibrium price this must be
caused by either a shift to one (or both) of supply and demand, and therefore a
movement along the other.

7. The Impact of changes in Demand & Supply on Equilibrium
Diagram: Shifts in the demand curve
An increase in demand will see the demand curve shift
outwards, towards the right from D to D1. This will
cause price to rise to P1 and quantity demanded to Q1.
At this point we have a new market equilibrium (P1
Q1).
The shift in demand has led to a movement along the
supply curve.
Diagram: Shifts in the supply curve
An increase in supply will see the supply curve shift
outwards, towards the right from S to S1. This will
cause price to fall to P1 and quantity supplied to rise to
Q1.
At this point we have a new market equilibrium (P1
Q1).
The shift in supply has led to a movement along the
demand curve.
Price
Quantity
D
P
Q
S
P1
Q1
S1
D1
Price
Quantity
D
P
Q
S
P1
Q1

8. The Functions of
the Price Market
Mechanism
Price Determination via the Price Market
Mechanism
Mr O’Grady

9. The Functions of the Price Market Mechanism
Price Market Mechanism: the means by which millions of decisions taken by
consumers and businesses interact to determine the allocation of scarce resources
between competing uses. The price mechanism plays three important functions in
a market:
The Rationing Function:
Excess demand for a good or service will lead to a rise in the price of a good or service
This is due to the relative scarcity of the product
The price rise will lead to a reduction in demand
The more scarce a product the higher the price
This leads to a rationing of the product as its use is restricted (fewer people are willing to pay
for it)
There will be a movement along the demand curve showing a decrease in quantity
demanded and an increase in price

10. The Incentive Function:
Higher prices act as a motivator for producers to increase the supply of a good or service
This is due to greater contribution per unit i.e. the difference between selling price and
variable cost
As prices rise so do revenue and profit
There will be a movement along the supply curve showing a increase in quantity supplied
because of an increase in price
The Signalling Function:
An increase in price will give an indication to producers that they should increase supply
An increase in price will give an indication to consumers that they should reduce demand
A decrease in price will give an indication to producers that they should decrease supply
A decrease in price will give an indication to consumers that they should increase demand
All of these signals will push the market towards equilibrium

11. The Effectiveness
of Markets in
Allocating
Resources
Price Determination via the Price Market
Mechanism
Mr O’Grady

12. Quick efficiency recap
Efficiency: is important for economists and there are a variety of efficiencies that
come under the umbrella heading economic efficiency.
Allocative efficiency: occurs where consumer satisfaction is maximised in the production of
goods and services. Society is producing goods to match the needs of consumers.
At this point quantity supplied will equal quantity demanded
Productive efficiency: occurs when each unit of output uses the fewest number of resources
possible for that unit
Production has no extraneous wastage.
Illustrating both productive and allocative efficiency can be using a PPF:
Good Y
Good X
•
•
A
B
All points on the PPF are productively efficient including
points A and B
However, if good Y is in greater demand than good X then
production at point A will be more allocatively efficient
than that of point B.
Therefore allocative efficiency can be found at one point
on the PPF but where depends upon society’s preference.

13. The Effectiveness of Markets in Allocating Resources
How does the market achieve allocative efficiency?
Allocative efficiency is difficult to identify as we need to match consumer
preferences to producer output
i.e. we need to match demand and supply
Markets do not always operate at the market clearing price due to:
Excess supply (S>D)
Excess demand (D>S)
But, market forces do push prices towards equilibrium where quantity demanded
will equal quantity supplied
Therefore, competitive and free markets help to move the market outcome
towards achieving allocative efficiency

14. Price
Quantity
D
P1
S
P2
Q1Qs Qd
In diagram A suppose the market price is P2. The last unit
that consumers value at that price is low at Qd. However,
firms produce more than this at Qs.
Consumers are not willing to pay the higher price so price
will fall and firms will reduce supply.
This might lead to a reallocation of a firms’ resources to
another use e.g. away from apples (to bananas).
Price
Quantity
D
P1
Q1
S
P2
QsQd
In diagram B suppose the market price is P2. The last unit
that consumers value at that price is high at Qd.
However, firms produce less than this at Qs.
Consumers are willing to pay the higher price so price
will rise to P1 and firms will increase supply.
This might lead to a reallocation of a firms’ resources
from another use e.g. into bananas (from apples)
Effective Allocation in Action
A - Apples B - Bananas
Result: In the long run, should apples be produced at Q1 and bananas produced at Q1 we will have allocative
efficiency.

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