# 1.2 How Markets Work

Rationing Function of the Price Mechanism
Whenever resources are particularly scarce, demand exceeds supply and prices are driven up.
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Signalling Function of the Price Mechanism
Rising prices give consumers a signal to reduce demand and signals suppliers to produce more; falling prices give consumers a signal to increase demand, and suppliers the signal to decrease production.
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Incentive Function of the Price Mechanism
Higher prices provide an incentive for producers to supply more.
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Supply
The volume of goods and services that firms are willing to supply at each price level.
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Shifts in the supply curve (PINTS/WC)
Productivity, Indirect tax, Number of firms, Technology, Subsidies, Weather and Cost of production.
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Price Elasticity of Demand (PED)
How responsive demand of a product is to a change in price.
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PED formula
%change in quantity demanded/ %change in price
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Interpreting PED values
Anything below 1 is inelastic, anything above 1 is elastic.
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Percent change
Difference/ First figure x 100
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Inelastic goods
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Elastic goods
Luxury, lots of competition
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Cross Elasticity of Demand (XED)
This measures how much demand of one product changed following a change in price of another.
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XED formula
%change in the Quantity demanded of Product A/ %change in the price of product B
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XED interpretation
If XED is positive then the products are substitute, if its negative then the products are complements.
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Income Elasticity of Demand (YED)
This measures how responsive demand of a product is to a change in people's income.
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YED formula
%change in quantity of demanded/ %change in income
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YED interpretation
If YED is positive then goods are classed as normal goods, if YED is negative then goods are classed as inferior.
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Price Elasticity of Supply (PES)
This measures how responsive supply is to a change in price.
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PES formula
%change in supply/ %change in price
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Consumer Surplus
The difference between the price the customer is willing to pay and the price that they do pay.
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Producer Surplus
The difference between the actual market price and the price that they were willing to supply at.
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Indirect Tax
When tax is applied per unit or volume sold.
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A tax applied as a percentage of the selling price.
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Subsidies
Represents payments to producers by the Government which reduces their production costs.
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Factors which influence PES
Transferbility of resources, Short-term or Long-term, How long production takes and How easy it is to stock pile supply.
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## Other cards in this set

### Card 2

#### Front

Rising prices give consumers a signal to reduce demand and signals suppliers to produce more; falling prices give consumers a signal to increase demand, and suppliers the signal to decrease production.

#### Back

Signalling Function of the Price Mechanism

### Card 3

#### Front

Higher prices provide an incentive for producers to supply more.

### Card 4

#### Front

The volume of goods and services that firms are willing to supply at each price level.

### Card 5

#### Front

Productivity, Indirect tax, Number of firms, Technology, Subsidies, Weather and Cost of production.

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