Price Mechanism | A-Level Economics Notes

These revision notes cover everything you need to know about the Price Mechanism for A-Level Economics. They're designed for students studying AQA A-Level Economics, Edexcel A-Level Economics, and Edexcel International A-Level Economics. Written by Jaisul Naik, UCL Economics graduate and A-Level Economics tutor since 2017.

Increase in demand

1. The diagram below shows an increase in demand, which can be caused by factors like an increase in income.
2. At the old market price p1, there is an excess demand.
3. Firms notice this through market signals as they may see larger queues of customers waiting to be served,
4. Firms respond by raising prices.
5. The new market price p2 is higher so firms are incentivised to expand their supply to make higher profits, whilst consumers are incentivised to contract their demand.
6. The market clears at the new equilibrium quantity of q2 where excess demand has been rationed.

Decrease in demand

1. The diagram shows a decrease in demand.
2. At the old price p1, there is an excess supply.
3. This information is signalled to firms, for example they may empty shops.
4. Firms respond by decreasing prices.
5. This incentivises firms to c0nsumers to expand demand and it incentivises firms to contract their supply due to lower profits.
6. Overall, the market clears at a new equilibrium at q2, where the excess supply is rationed away.

Decrease in supply

1. The diagram shows a decrease in supply.
2. At the old market price p1, there is an excess demand.
3. This information gets signalled to producers; they may see an increase in the number of customers waiting.
4. Firms respond by increasing prices.
5. A higher prices incentivises producers to expand their supply due to higher profit and it incentivises consumers to contract their demand.
6. Overall, the market clears at a new equilibrium at q2, where the excess demand is rationed away.

Increase in supply

1. The diagram shows an increase in supply.
2. At the old price p1, there is an excess supply.
3. This information is signalled to firms, for example they may empty shops.
4. Firms respond by decreasing prices.
5. This incentivises firms to c0nsumers to expand demand and it incentivises firms to contract their supply due to lower profits.
6. Overall, the market clears at a new equilibrium at q2, where the excess supply is rationed away.

Summary questions

1. How does the price mechanism respond to
   1. an increase in demand
   2. a decrease in demand
   3. a decrease in supply
   4. an increase in supply

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