H2 Price Mechanism (Part I)

What is the main function of the price mechanism in a free market?

• Allocation of resources

• Regulation of prices

• Control of demand

• Redistribution of wealth

Answer explanation

The main function of the price mechanism in a free market is the allocation of resources, where prices act as signals to direct resources to where they are most needed or valued.

What is the law of demand?

• Inverse relationship between price and quantity demanded

• Direct relationship between price and quantity demanded

• No relationship between price and quantity demanded

• Fluctuating relationship between price and quantity demanded

What is the law of supply?

• Direct relationship between price and quantity supplied

• Inverse relationship between price and quantity supplied

• No relationship between price and quantity supplied

• Fluctuating relationship between price and quantity supplied

Answer explanation

The law of supply states that there is a direct relationship between the price of a good and the quantity supplied by producers.

What happens to the equilibrium price and quantity when market demand rises?

• Price decreases, quantity increases

• Price increases, quantity decreases

• Both decrease

• Both increase

What happens to the supply curve when the unit cost of production decreases?

• It becomes steeper

• It shifts left

• It shifts right

• It remains unchanged

Answer explanation

When the unit cost of production decreases, the supply curve shifts right because producers can now supply more at each price point due to lower costs.

What is the impact of an increase in demand on producer surplus?

• It remains the same

• It decreases

• It increases

• It becomes negative

Answer explanation

An increase in demand leads to higher prices, resulting in an increase in producer surplus as producers can sell goods at a higher price than before.

What is the signalling function of prices in the market?

• Prices adjust to demonstrate where resources are required

• Prices adjust to demonstrate where resources are abundant

• Prices remain constant regardless of market conditions

• Prices fluctuate randomly

Answer explanation

Prices adjust to demonstrate where resources are required, signaling the market to allocate resources efficiently.

How is productive efficiency achieved in a free market?

• By producing with the most expensive inputs

• By producing with inefficient methods

• By producing with the least cost combination of inputs

• By producing with excessive waste

Answer explanation

Productive efficiency in a free market is achieved by producing with the least cost combination of inputs.

How does an indirect subsidy affect the market equilibrium?

• It decreases consumer surplus

• It increases producer surplus

• It leads to a shortage of goods

• It has no impact on the market equilibrium