<2.3 COMPETITIVE MARKET EQUILIBRIUM>

--THINK AHEAD--

"Do you think your school's study fees are too high?" , "How can you tell?", "How would your school actually know that this is the case?", "Would you be surprised if I told you that its probably underpriced?", "How do I know?"

--MARKET EQUILIBRIUM--

--WHAT IS THE DEFINITION OF MARKET EQUILIBRIUM?--

MARKET EQUILIBRIUM occurs when

QUANTITY DEMANDED = QUANTITY SUPPLIED

In other words when the forces of supply and demand are in balance and there is NO TENDENCY FOR THE PRICE TO CHANGE.
Diagrammatically it is at the point where the DEMAND CURVE INTERSECTS THE SUPPLY CURVE.
The PRICE in market equilibrium is called the 'EQUILIBRIUM PRICE', and the QUANTITY is the 'EQUILIBRIUM QUANTITY'.
At the equilibrium price, the quantity consumers are willing and able to buy is exactly equal to the quantity firms are willing and able to sell. This price is also known as the MARKET-CLEARING PRICE or simply MARKET PRICE.

--THINK AHEAD--

"How do we know that Labubu dolls are in short supply?"

--HOW DO MARKET FORCES REACT TO A 'SHORTAGE'?--

A 'SHORTAGE' occurs when the price of the product is set BELOW the equilibrium price. At this price the quantity demanded is greater than the quantity supplied.

When the price is set below equilibrium the price begins to be 'BID-UPWARDS' by CONSUMERS, like at an AUCTION, which in turn sends a price SIGNAL to producers that they can charge a higher price for the good. With the INCENTIVE of more profit, they will raise their price and REALLOCATE resources towards producing more of this good and hence increase the quantity supplied to satisfy the extra demand and the market will clear at a higher price and quantity.

--THINK AHEAD--

"How do we know that Man City ticket prices are too high?"

--HOW DO MARKET FORCES REACT TO A 'SURPLUS'?--

A 'SURPLUS' occurs when the price of the product is set ABOVE the equilibrium price. At this price the quantity supplied is greater than the quantity demanded.

When the price is set ABOVE equilibrium the PRICE TENDS DOWNWARDS as PRODUCERS will need to CUT THEIR LOSSES by offering price reductions. This lower price sends a SIGNAL to producers that they have an INCENTIVE to reduce output in this industry and REALLOCATE their resources towards producing a good with a rising price. The end result is a new lower equilibrium price and quantity.

--THINK AHEAD--

"When we set our price, we soon realised that the quantity demanded did not equal the quantity supplied, so the amount we actually transacted (sold to customers) was way below the equilibrium quantity, and we sold out!"

"Can you explain this situation using a diagram?"

--Q. TRANSACTED VS EQUILIBRIUM Q.--

QUANTITY TRANSACTED refers to the quantity of the good that is actually 'BOUGHT & SOLD',
When there is a SHORTAGE, it means that the PRICE IS SET BELOW EQUILIBRIUM therefore the quantity supplied is less than the quantity demanded, hence PRODUCERS only satisfy a portion of the quantity demanded, meaning QUANTITY TRANSACTED = QUANTITY SUPPLIED.
When there is a SURPLUS, it means that the PRICE IS SET ABOVE EQUILIBRIUM therefore the quantity supplied is more than the quantity demanded, hence CONSUMERS only demand a portion of the quantity supplied, meaning: QUANTITY TRANSACTED = QUANTITY DEMANDED.

--THINK AHEAD--

"Despite our costs of production falling, we still managed to sell more at a higher price than before!", "Despite demand rising sharply, we still managed to sell less than before!"

Q. "Can you explain these situations occurred using a diagram?"

--SHIFTS IN DEMAND & SUPPLY--

WATCH THESE VIDEOS AND SKETCH EACH DIAGRAM IN YOUR NOTEBOOK, THEN CHOOSE ONE FROM EACH TO EXPLAIN THE CHANGE IN EQUILIBRIUM PRICE AND QUANTITY [10]

-HOW DO SHIFTS IN EITHER SUPPLY OR DEMAND IMPACT PRICE AND QUANTITY?

-HOW DO SHIFTS IN BOTH SUPPLY AND DEMAND IMPACT PRICE AND QUANTITY?

--PRACTICE TIME!!--

SHIFT IN SUPPLY /OR/ DEMAND

SHIFTS IN BOTH SUPPLY AND DEMAND

--TASK--

--4-MARKET QUESTIONS: (DIAGRAM 2, EXPLANATION 2)--

Use a diagram to explain under what CONDITION an INCREASE IN DEMAND and an INCREASE IN SUPPLY will result in an INCREASE in both PRICE and QUANTITY TRANSACTED. (4)
Use a diagram to explain under what CONDITION an INCREASE IN DEMAND and a DECREASE IN SUPPLY will result in an INCREASE in PRICE and a DECREASE in QUANTITY TRANSACTED. (4)

--THINK AHEAD--

Imagine you are the central planner of socialist state, and you need to decide 'What to produce?', 'How to produce?' and 'For Whom to produce?' by organising your country's factors of production in order to satisfy as many wants as possible to keep your people happy, and maintain economic growth.

"How can you decide what people want and what they don't want?", "How do you make sure you don't waste scarce resources by allocating them to the production of a good nobody desires?", "How do you decide who gets to consume the goods first?", "How do you incentivise people to work harder if they don't earn any extra money?"

--FUNCTIONS OF THE PRICE MECHANISM--

--TASK--

"Last Saturday, a small sneaker shop released a limited-edition pair of trainers at $100. By the time the store opened, a queue of customers stretched around the block. Within two hours, every pair was sold out, and the shop had to turn people away. Seeing the massive demand, the owner decided to raise the price to $120 for the next drop and make double the number of sneakers for next month. Other nearby stores noticed the buzz and decided to start making similar shoes too."

"What was the signal that made the owner realise he had a product that people wanted more of?", "What motivated (incentivised) the owner to order more?", "What production decisions had to be made at the sneaker manufacturer's factory to get more shoes available for next month?", "How did the owner decide how to ration the limited supply to his customers?"

--THINK AHEAD--

"How did the founders of your school actually know that there was a demand for IBDP in your country?, "Did the government tell them?", "What metric do you think they observed changing to convince them to enter the market?", "Do you think this could occur in a planned economy?", "Why not?"

--THINK AHEAD--

"Imagine you are a regular coffee drinker. When the price of increased, what did it signal to you as a regular consumer?", "What did it signal to the producers of coffee as well as other drink makers?"

--'SIGNALLING FUNCTION'--

The price mechanism incorporates a 'SIGNALING FUNCTION' which refers to how changes in prices ACT AS SIGNALS to both PRODUCERS and CONSUMERS.
- - SIGNALS FOR PRODUCERS:

If DEMAND RISES => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product = MOVEMENT UP THE SUPPLY CURVE.
If DEMAND FALLS => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product = MOVEMENT DOWN THE SUPPLY CURVE.
If SUPPLY RISES => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product. = MOVEMENT DOWN THE SUPPLY CURVE.
If SUPPLY FALLS => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product = MOVEMENT UP THE SUPPLY CURVE.

SIGNALS FOR CONSUMERS:

If DEMAND RISES => SHORTAGE OCCUIRS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED, so consumers WANT LESS and seek CHEAPER SUBSTITUTES = MOVEMENT UP THE DEMAND CURVE.
If DEMAND FALLS => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED, so consumers WANT MORE = MOVEMENT DOWN THE DEMAND CURVE.
If SUPPLY RISES => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED so consumers WANT MORE= MOVEMENT DOWN THE DEMAND CURVE
If SUPPLY FALLS => SHORTAGE OCCURS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED, so consumers WANT LESS = MOVEMENT UP THE DEMAND CURVE

--THINK AHEAD--

"Do you think any entrepreneur would risk starting a business without the incentive of making profits?", "Would this school have opened if the founders were not incentivised by the prospect of profit?", "Do you think this school would exist in a socialist state?", "Do you think the X-BOX or the i-phone would have been invented in the first place?", "Do you think this could occur in a planned economy?", "Why not?"

--'INCENTIVE FUNCTIION'--

The 'INCENTIVE FUNCTION' of price refers to how PRODUCERS are INCENTIVIZED TO LISTEN TO THE CONSUMER and provide them the goods and services they wish for, as they have the INCENTIVE (REWARD) of GREATER PROFIT as price and quantity increase, which in a market economy, they can keep the majority of for themselves (Unlike in a planned economy). Hence a good with a rising price will motivate them to supply more, whereas a falling price will INCENTIVISE PRODUCERS to CUT THEIR LOSSES and SUPPLY LESS.
The 'INCENTIVE FUNCTION' of price also refers to how CONSUMERS are INCENTIVIZED TO MAXIMISE THEIR SATISFACTION by BUYING MORE when the price FALLS, or BUYING LESS when the price RISES.

- - INCENTIVES FOR PRODUCERS:

If DEMAND RISES => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product => INCENTIVISES PRODUCERS to supply more as they make MORE PROFIT.
If DEMAND FALLS => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product => INCENTIVISES PRODUCERS to supply less as they make LESS PROFIT (or LOSSES)
If SUPPLY RISES => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product. => INCENTIVISES PRODUCERS to supply less as they make LESS PROFIT (or LOSSES)
If SUPPLY FALLS => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product INCENTIVISES PRODUCERS to supply more as they make MORE PROFIT.

INCENTIVES FOR CONSUMERS:

If DEMAND RISES => SHORTAGE OCCURS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED => INCENTIVISES SOME CONSUMERS to REDUCE THEIR CONSUMPTION and enjoy ALTERNATIVE CHEAPER SUBSTITUTES.
If DEMAND FALLS => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED => INCENTIVISES SOME CONSUMERS that the OPPORTUNITY COST of consuming this good has DECREASED so they should INCREASE THEIR CONSUMPTION and enjoy LESS MORE EXPENSIVE SUBSTITUTES.
If SUPPLY RISES => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED => INCENTIVISES SOME CONSUMERS that the OPPORTUNITY COST of consuming this good has DECREASED so they should INCREASE THEIR CONSUMPTION and enjoy LESS MORE EXPENSIVE SUBSTITUTES. .
If SUPPLY FALLS => SHORTAGE OCCURS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED => INCENTIVISES SOME CONSUMERS to REDUCE THEIR CONSUMPTION and enjoy ALTERNATIVE CHEAPER SUBSTITUTES.

--THINK AHEAD--

"Over the past few years have you noticed any SUBJECT areas becoming MORE POPULAR while others are becoming LESS POPULAR?", "How has the school reacted, in terms of ALLOCATION OF THEIR RESOURCES?", "Do you think this could occur in a planned economy?", "Why not?"

--'ALLOCATIVE FUNCTIION'--

-WHAT IS THE 'REALLOCATION FUNCTIION' OF THE PRICE SYSTEM? When the signals occur and with the incentive of profit and/or loss reduction, producers will REALLOCATE their productive resources accordingly.
If the PRICE of a good is RISING, the producer will ALLOCATE MORE RESOURCES TO THIS PRODUCT and the quantity supplied will rise, similarly,
if the PRICE of the good is FALLING, the producer will ALLOCATE LESS RESOURCES TO THIS PRODUCT and reduce the quantity supplied, and in turn reallocate these resources to the market for the good, which is rising in price.

--THINK AHEAD--

"When the Titanic sank, how did they ration the limited life jackets and spots on the lifeboats?", "When universities fill up their courses how do they ration the limited number of places?", "When the school coach rations the limited number of spots on the school's 1st-team how does he decide?", "How does Front Man ration the prize money in Squid Games?"

"What do all these rationing systems have in common?", "How was your schol place rationed at this school?"

--'RATIONING FUNCTIION'--

-What is the 'RATIONING FUNCTIION' of the price system? This question refers to the how the 'For whom to produce' question is answered in a market system.
Unlike in a planned system where methods such as 'first-come-first-served', rank & status may be used to decide who consumes the output, in a market system that uses a price system, the distribution of the goods is solely decided by the ability and willingness to pay the market price.

--TASK--

Explain using the 'FUNCTIONS OF THE PRICE MECHANISM' mentioned above how and why the owner of a Coffee shop made the decision to close down, refurbish, and open a bubble tea shop at the local mall. (10)

--PRICE MECHANISM IN ACTION!--

--DIGITAL STORYTELLING TASK--

WATCH THE VIDEO BELOW RELATED TO HOW THE PRICE MECHANISM WORKS TO REALLOCATE RESOURCES FOLLOWING AN 'INCREASE IN DEMAND', THEN CREATE YOUR OWN VIDEO SCRIPT AND VIDEO, EXPLAINING HOW THE PRICE MECHANISM REACTS FOLLOWING EITHER:
- - - - 1) 'DECREASE IN DEMAND'
        2) 'DECREASE IN SUPPLY
        3) INCREASE IN SUPPLY
- *REMEMBER TO INCLUDE BOTH THE PRODUCER AND CONSUMER SIDES*
  - - - HOW?:
        If you have a stylus and tablet, then this is easily accomplished using a free screen recorder such as ScreenRec, as you sketch simply narrate your script
        If you have a mobile phone, film yourself sketching the diagram on a sheet of paper and narrate as you draw.

--THINK AHEAD--

"Why do you think it is considered efficient that this person got to purchase the new i-phone?", "Why would this outcome be desirable in terms of the rationing function of the free market?"

"Why do you think it is considered efficient that coke got to supply Coke Cola?", "Why would this outcome be desirable in terms of the allocating function of the free market?"

--INTRO TO ECONOMIC EFFICIENCY--

--TASK--

The two videos below feature ideas that are fundamental to what is considered economic efficiency in a free market price system. Watch them and answer these important questions.

(Video#1) "What do you notice about the consumers at high prices in terms of their perceived benefit?", "What can we conclude about the relationship between consumers' willingness to pay and their benefit?"
(Video#2) "What do you notice about the producers at low prices in terms of their costs of production and opportunity cost?"

--ANSWER/CONCLUSION--

From the task above, we can see that in a free market,
@ lower prices, the first units of a good are always supplied by those producers who can produce most cheaply ('low-cost producers of oil = e.g. Saudi Arabia') and as the price increases, producers with higher costs are willing to join in (e.g. oil-rig producers), and
@ higher prices, the first units are bought by those consumers who value the good the highest and are thus willing to pay the most (value them the most = 'high-value consumers' = e.g. the Airline companies) and when prices fall, consumers who value the good less are also willing to join in (e.g. the rubber duck manufacturers).
The above should lead you to the following conclusion:
"In a free market the equilibrium quantity is produced by the lower-cost, least wasteful producers and is consumed by those consumers who derive the greater levels of satisfaction."
Ask yourself, "Is this scenario possible without a price mechanism?"

--DEFINITION--

So we have just concluded that...
"In a free market the equilibrium quantity is produced by the lower-cost, least wasteful producers and is consumed by those consumers who derive the greater levels of satisfaction."
...now if we define economic efficiency as follows...
"Economic (or Allocative) efficiency occurs when the greatest possible consumer benefit is achieved at the lowest overall economic cost, including opportunity cost."
"What can we conclude about economic efficiency and equilibrium quantity?"

--THINK AHEAD--

"If you were willing to pay a high price for a good, and your friend a lower price, but you both ended up paying an even lower price, who would be the most delighted?"

"If you were willing to accept a low price for selling a good, and your partner a higher price, but you both ended up receiving an even higher price, who would be the most delighted?"

"Can we measure these various levels of delight?"

--CONSUMER & PRODUCER SURPLUS--

--HOW TO MEASURE BENEFIT?--

From the first part of the 'Think ahead' we should have realised that "There is a difference between what a consumer is willing to pay and what they actually pay" and that "It's different for every consumer." Then from this we can logically conclude that "The consumers with the largest difference are those that value-the good the most".
"But why is this important?" Well, if we ever wish to quantify the actual benefit created at the efficient level of output, we need to have a 'metric,' and it is this extra/surplus/ level of delight/benefit for the consumer that is the measure we use on the consumer side, and it is called CONSUMER SURPLUS.

--DIAGRAM: CONSUMER SURPLUS--

Consumer surplus can be shown diagramatically, as the demand curve shows the willingness to pay and the expected benefit that the good will give the consumer, whilst the equilibrium price shows the price that is actually paid, we can conclude that the difference between these two prices for each unit is equal to the total area BELOW the demand curve and ABOVE the actual price

We can see that this individual was willing to pay up to $10 for the 1st cup, up to $6 for the 2nd, and up to $2 for the 3rd cup, therefore if the equilibrium price is $2 per cup, they will buy 3 cups, and the consumer surplus will be...
On the 1st Cup, his CS is $10 - $2 = $8
On the 2nd Cup, his CS is $6 - $2 = $4
On the 3rd Cup, his CS is $2 - $2 = $0
Total CS = $8 + $4 + $0 = $12

--HOW TO MEASURE COST?--

Referring back to the 'Think ahead,' we should have concluded that "There is a difference between what a producer is willing to accept and what you actually receive," and that "It's different for each producer." Then from this we can logically conclude that "the producers with the largest difference are those that have the lowest costs."
"But why is this important?" Well, if we ever wish to quantify the actual benefit created at the efficient level of output from having low-cost, efficient producers, we need to have a 'metric,' and it is this extra/surplus level of delight/benefit received by the producers that is the measure we use on the producer side, and it is called PRODUCER SURPLUS.

EXTRA???
If we take the example above a step further, we can realise that a person's willingness to supply is based not only on whether they can make a profit by covering their raw material, rent, etc., but also whether it is enough to 'COMPENSATE' them for giving up the income they could have earned using their resources elsewhere (Hence a judge will never give up his salary to work in 7-11, even if he was making a profit there, as his/her opportunity cost is way too high)
This implies that at LOW PRICES only THE MOST (SUITABLE) PRODUCTIVE and LOW-COST FIRMS will be WILLING TO SUPPLY, whilst at HIGHER PRICES the LESS PRODUCTIVE and HIGHER-COST FIRMS will enter, as such, THE AREA UNDER THE SUPPLY CURVE REPRESENTS TOTAL COST.
Thus a well-functioning and efficient economic system should ensure that this producer with the lowest cost gets to produce the good ahead of the higher cost producers.

--DIAGRAM: PRODUCER SURPLUS--

Producer surplus can be shown diagrammatically, as the supply curve shows the willingness to supply and the expected profit that the good will give the producer, whilst the equilibrium price shows the price that is actually received. We can conclude that the difference between these two prices for each unit is equal to the total area ABOVE the supply curve and BELOW the actual price.

We can see that this individual firm was willing to accept at least $2 for the 1st cup, at least $6 for the 2nd, and at least $10 for the 3rd cup, therefore if the equilibrium price is $10 per cup, they will produce 3 cups, and the producer surplus will be...
On the 1st Cup, the PS is $10 - $2 = $8
On the 2nd Cup, the PS is $10 - $6 = $4
On the 3rd Cup, the PS is $10 - $10 = $0
Total PS = $8 + $4 + $0 = $12

--TOTAL SOCIAL SURPLUS & EFFICIENCY--

TOTAL SOCIAL SURPLUS? (TSS), refers to the TOTAL BENEFIT TO SOCIETY THAT THE FREE-MARKET SYSTEM HAS CREATED and is equal to the SUM OF BOTH CONSUMER SURPLUS + PRODUCER SURPLUS.

We see in the diagram below that at the efficient level of output (THE ALLOCATIVELY EFFICIENT LEVEL) TSS is maximised (Qe), and any output level below Qe will result in LOST BENEFIT, which is referred to as a 'DEADWEIGHT LOSS'.
Q DO CS & PS HAVE TO BE EQUAL AT EQUILIBRIUM?

--THINK AHEAD--

"You have a final exam in 5 days. Your goal is to get the best possible grade. The first hour of studying: You're reviewing easy concepts. The marginal benefit (the likely increase in your exam score) is very high. The marginal cost (one hour of your time, not watching Netflix) is relatively low. MB > MC. Should you study or give up?"

"By the tenth hour of studying: You're drilling obscure details. The marginal benefit is much lower (this might only bump your score up from a 94% to a 95%). The marginal cost is now very high (lost sleep, stress, missed social time). MB < MC. Should you study or give up?"

"What can we conclude about how decisions about the value of a unit (in this case an extra hour of study) are made?", "What is it that we compare for each unit?", "When do we decide something is/isn't worthwhile doing?" and "How can this help us answer whether the production of a unit of a good or service is beneficial to society?"

--MARGINAL ANALYSIS--

--YES ANOTHER METHOD!!!!--

--MB MINUS THE LEAST RESOURCES--

As an individual consumer, the price you are willing to pay for each unit reflects your MARGINAL BENEFIT from consuming that unit, right? so that must mean the area below your demand curve is also your TOTAL BENEFIT
As an individual producer, the price you are willing to accept reflects your MARGINAL COST from producing that unit, right? So that must mean the area below your supply curve is also your TOTAL COST.
So if we combine the total benefit and total costs of all the customers and producers in the market, we arrive at SOCIETY'S TOTAL BENEFIT and SOCIETY'S TOTAL COST, and we can see that at the equilibrium quantity, the level of BENEFIT MINUS COST is at its maximum. Therefore, another way to express why the equilibrium quantity is the most efficient is to say that at this output level...
At equilibrium, the sum of consumer surplus + total producer surplus is maximised. That’s why economists say the market is allocatively efficient — all the units where benefit was higher than cost have been produced and bought. No more, no less.
"the greatest possible consumer benefit is attained at the lowest overall economic cost."

--CALCULATIONS (HL ONLY)--

--CALCULATING TSS--

--...IF PRICE IS FIXED ABOVE Pe--

--...IF PRICE IS FIXED BELOW Pe--

--INTERACTIVE PRACTICE--

--PAST PAPER TASK--

Use the markscheme below to create a model answer.

--ALLOCATIVE EFFICIENCY IN COMPETIT

Discuss the view that competitive markets will always achieve allocative efficiency.

Discuss the view that a free market at competitive market equilibrium leads to the most efficient allocation of resources from society’s point of view.

Explain that when producer surplus and consumer surplus are maximized, allocative efficiency is achieved.

IVE MARKETS--

--WHY IS THIS IMPORTANT?--

ECONOMICS is ultimately about how economies ALLOCATE THEIR SCARCE RESOURCES in order to SATISFY THE MOST WANTS.
As we know, with a PLANNED ECONOMY the WHAT TO PRODUCE? and the HOW TO PRODUCE? questions are ANSWERED BY THE GOVERNMENT, hence we have NO WAY OF KNOWING whether the CONSUMERS GET THEIR WANTS SATISFIED, nor whether the PRODUCERS ARE DOING THEIR BEST TO BE AS LOW-COST & EFFICIENT as possible.
However in a MARKET SYSTEM that utilises a PRICE MECHANISM the WHAT TO PRODUCE is guided by CONSUMER DESIRES, and the HOW TO PRODUCE is guided by producers being as efficient as possible in order to MAKE HIGHER PROFITS.
Therefore if we look at how the SUPPLY CURVE works, AT LOW PRICES, ONLY THE MOST COST-EFFECTIVE FIRMS ARE ABLE TO TURN A PROFIT, and as price rises, other higher cost and less efficient producers will progressively enter, and so on, with more and more higher-cost producers entering as price rises.
Similarly, if we look at the DEMAND CURVE AT HIGH PRICES ONLY THOSE CONSUMERS WHO RECIEVE THE MOST UTILITY WILL OFFER TO PAY THE HIGH PRICES however as the price falls, other consumers with progressively lower utilities will enter the market, and so on.
Given this, we can say that the EQUILIBRIUM QUANTITY produced, SATISFIES THE MOST WANTS at the LEAST COST.
This level of output is also referred to as the ALLOCATIVE EFFICIENT LEVEL OF OUTPUT.

--RELATED PAST PAPER QUESTIONS & MS--

Explain one supply factor and one demand factor that might lead to a rise in the price of rented housing. Demand refers to.... supply refers to.... A rise in the price of rented housing can occur as a result of either an increase in demand or a decrease in supply. An increase in demand for rented housing could be caused by increases in the population or a rise in incomes allowing young people to move out of their familiy homes. We can illustrate how this will result in a rise in price by looking at figure 1.
An increase in demand for rented housing could be caused by increases in the population or a rise in incomes allowing young people to move out of their familiy homes. We can illustrate how this will result in a rise in price by looking at figure 1.
Explain how changes in price work to reallocate resources in a market. Changes in price send signals to producers that goods are either desired via a rise in price following an increase in demand, or undesired via a fall in price following a decrease in demand. When goods are desired, producers have the incentive of more profit, to supply more, hence they will allocate more resources towards the production of this good, similarly, when goods are no longer desired, producers have an incentive to reallocate resources away from the production of this good and towards the production of goods with rising prices, hence we can say that the prices have sent signals to the producers about 'What to produce'
Explain how the price mechanism allocates resources in an economy.
Explain that when consumer surplus and producer surplus are maximized, allocative efficiency is achieved.
With reference to demand and supply in competitive markets, explain how the economic question “what to produce” is answered.: Changes in price send signals to producers that goods are either desired via a rise in price following an increase in demand, or undesired via a fall in price following a decrease in DEMAND. When goods are desired, producers have the incentive of more profit, to SUPPLY more, hence they will allocate more resources towards the production of this good, similarly, when goods are no longer desired, producers have an incentive to reallocate resources away from the production of this good and towards the production of goods with rising prices, hence we can say that the prices have sent signals to the producers about 'What to produce?'
Explain how an increase in the price of air travel might affect the demand for its complements and substitutes: An increase in the price of air travel, should result in a fall in demand for complementary goods such as long-haul holidays, hotels and luggage, whereas it should result in a rise in demand for its substitutes such as domestic holidays, and other forms of transport such as trains and ferries.
Explain how the price mechanism reallocates resources when there is an increase in demand for a good or service
Explain two reasons why a government might impose an indirect tax on a good.
Explain how an increase in the costs of factors of production would affect the market price and output of a good.
With reference to the concept of excess demand, explain how a decrease in supply of a good would lead to a new market equilibrium.
Explain three factors that could led to an increase in the demand for cigarettes.
Explain the view that an increase in price will lead to a decrease in the quantity demanded while an increase in demand will lead to an increase in price.
Explain why an increase in incomes over time may lead to an increase in demand for some goods but a decrease in demand for other goods.
Explain two factors that would lead to an increase in the demand for a product.
Discuss the view that competitive markets will always achieve allocative efficiency.
Using diagram(s), explain the signaling and incentive functions of price.
Using diagrams, explain how a change in one of the determinants of demand might increase the price of rice and how a change in one of the determinants of supply might decrease the price of rice.
Explain two factors which could shift a firm's supply to the left

--HIGH-EQUITY CONSUMERS CONSUME--

As PRICE FALLS, the QUANITY DEMANDED RISES as more consumers enter the market attracted by the falling price. When they enter, they are expressing their willingness to pay the price, which in turn reflects their personal expected satisfaction.
Clearly, those who enter at higher prices believe the product will give them a greater level of satisfaction than those who enter at lower prices.
Hence once an actual single price is determined, the people that pay it are all those consumers who were willing to pay more for it, while those that valued it below that price don't actually get to consume it.

--LOWEST-COST PRODUCER PRODUCE--

LOWEST-COST PRODUCERS SUPPLY THE PRODUCT: As price rises, the quantity supplied increases as more and more producers enter the market attracted by the rising price. When they enter, they are expressing their willingness to receive that price for each unit of their output, which in turn reflects the fact that they are sufficiently productive to ensure that their costs are low enough for them to make a profit (Or else why would they enter in the first place).
Clearly, those who enter at lower prices are able to do so because they have lower unit costs and are more productive than those producers who enter at higher prices. Hence once an actual single price is determined, the firms that accept it are all those producers who were willing to accept less, while those that required a higher price above the equilibrium price don't actually get to supply it.

--HOW DO YOU DETERMINE THE ALLOCATIVELY EFFICIENT LEVEL OF OUTPUT?--

Ok, so far we have learned that the free market forces of demand and supply, determine the equilibrium price and quantity, we have also learned that at the equilibrium output total social surplus is maximized, and the system has allowed for the consumers with the most desire to consume the goods, whilst the producers with the lowest costs produce the goods. Now, just to add to the confusion, another few terms are frequently used to refer to this equilibrium-social surplus maximizing level of output, and that is 'THE ALLOCATIVELY EFFICIENT LEVEL OF OUTPUT', or 'THE SOCIALLY OPTIMAL LEVEL OF OUTPUT'.

--TASK--

Using the individual consumers and producer cards, CONSTRUCT the market demand and supply curves and DERIVE the following:

Equilibrium Price.
Equilibrium Quantity.
Consumer Surplus.
Producer Surplus.
Which producer earns the greatest PS?
Which consumer earns the greatest CS?

https://pdfhost.io/v/I6rg5yssR_MARKET_EQUILIBRIUM_ACTIVITY_SHEET

--THINK AHEAD--

"Can you imagine a world without prices?"

From the PRODUCER'S perspective:

"How would producers get signals about what goods and services consumers actually desire and what goods they no longer want?", "How would producers know which products they should reallocate their scarce productive factors towards and which products to reallocate them away from to avoid waste and meet customer demand?" "Given scarcity, how would producers work out how to ration their limited products to those consumers who actually get the most satisfaction from consuming them, as opposed to those who aren't that interested?", "If there were no prices to reward producers for producing popular goods, what incentive would they have to keep producing more of them or improving quality?"
We have all been brought up in a MIXED ECONOMIC SYSTEM in which the PRIVATE SECTOR uses a PRICE MECHANISM to guide producers and consumers with regard to their decision-making.
In order to fully understand the functions of a price mechanism, we need to contrast each function with a system that has no price mechanism, namely a PLANNED ECONOMY, think the former USSR or N. KOREA.

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