1.2.7 The price mechanism Quiz: Pearson Edexcel Economics A, Unit 1

The 20 questions

1. Which function of the price mechanism determines who gets a good when it is scarce?

   • Redistribution, since prices move income from high earners to low earners in the economy.
   • Signalling, since prices show the government which goods should be banned from the market.
   • Incentive, since prices tell producers to make goods that consumers have already bought.
   • Rationing, since higher prices allocate scarce goods to those willing and able to pay for them.

2. Which function of the price mechanism tells producers to expand production of a good?

   • Incentive, since a higher price raises the reward for supplying more of the good.
   • Redistribution, since a higher price moves income from consumers to the state in the market.
   • Signalling, since a higher price shows consumers that they must reduce their demand.
   • Rationing, since a higher price removes buyers from the market and so frees up supply.

3. A rise in the price of a good signals to consumers that:

   • The good has become relatively scarcer, so they may wish to buy less of it.
   • The good has become cheaper relative to other goods, so they should buy more of it.
   • The government has decided to subsidise the good and so it will be cheaper next year.
   • Producers have reduced output because demand has fallen sharply in the market.

4. Which market is most likely to have the widest geographic reach for the price mechanism to operate?

   • A national market for haircuts that are provided by barbers in one town.
   • A local market for fresh bread sold in a single village shop on one high street.
   • A local market for piped water supplied to households in one neighbourhood.
   • A global market for crude oil, where prices are set by traders across many countries.

5. Which factor would limit the operation of the price mechanism in a local market compared with a global market?

   • Local buyers have unlimited access to all goods in the world, so prices always reflect global supply.
   • Local markets are always cheaper, so the price mechanism has no role in allocating goods there.
   • Local markets have no competition at all, so the price mechanism works more efficiently than in global markets.
   • Fewer buyers and sellers means that price signals travel less widely, so adjustment may be slower and prices more variable.

6. A factory in one country has a labour shortage and bids up wages. How does this illustrate the price mechanism in a global market?

   • Higher wages reduce the output of the factory, since workers are less motivated when they earn more.
   • Higher wages show that the price mechanism has failed, so the government must set wages for all workers.
   • Higher wages have no effect on the allocation of labour, since workers are paid by fixed contracts in every market.
   • Higher wages signal scarcity of labour, encourage workers to move to the sector, and may draw in workers from other places.

7. Why is the price mechanism described as allocating resources without central direction?

   • Consumers are allocated goods by lottery, so the price mechanism plays no part in the allocation process.
   • Prices are set by a central authority which then tells every firm what to produce and sell each year.
   • Firms decide prices together with the government, so no individual buyer or seller affects the outcome.
   • Individual buyers and sellers respond to prices, and the resulting pattern of production and consumption emerges without a central plan.

8. Which of these best describes the price mechanism acting as a signal?

   • A change in the price of a good conveys information to buyers and sellers about changes in its relative scarcity or value.
   • A change in the price of a good is a measure of the total number of people who live in the local area.
   • A change in the price of a good is a fixed amount that is unaffected by supply or demand in any period.
   • A change in the price of a good is a legal instruction from government that all firms must follow in the market.

9. A drought reduces the supply of fresh vegetables. Which sequence best describes how the price mechanism responds?

   • Prices fall, which encourages consumers to buy more and so reduces the shortage of vegetables.
   • Prices rise, which rations demand, signals scarcity and encourages growers and importers to supply more.
   • Prices rise, but producers reduce supply because higher prices make vegetables less profitable to grow.
   • Prices stay the same, and shortages are removed by consumers switching to other products automatically.

10. Evaluate: does the price mechanism always allocate resources in the best interests of society?

    • Yes, because the price mechanism ensures every person has equal access to goods regardless of their income.
    • Not always, since it responds to ability to pay, so it may leave low-income groups without access even when efficiency is achieved.
    • Yes, because the price mechanism always allocates goods to those who need them most in every society.
    • No, because the price mechanism never allocates goods efficiently in any market at any time.

11. A government sets a price ceiling on a good below the equilibrium price. Which function of the price mechanism is most affected?

    • Signalling, since the ceiling has no effect on the information conveyed by prices in the market.
    • Redistribution, since the ceiling only changes the amount that producers pay in taxes to the state.
    • Rationing, since the ceiling stops prices from allocating the limited supply and queues or other methods may replace it.
    • Incentive, since the ceiling increases the rewards for producers to supply more in every period.

12. Why does a rise in the price of a good often lead to a fall in quantity demanded even though the good remains in demand?

    • Consumers stop wanting the good completely as soon as its price rises above the price they paid before.
    • Consumers have more money after a price rise, so they buy less of everything in the market.
    • Consumers respond to the higher relative price by buying less of the good and substituting other goods.
    • Producers reduce the quality of the good when the price rises, so consumers choose not to buy it.

13. Which of the following is an incentive effect of the price mechanism for consumers?

    • A fall in the price of a good encourages producers to reduce their output to avoid losing revenue.
    • A rise in the price of a good encourages consumers to produce more of it at home for themselves.
    • A fall in the price of a good encourages consumers to buy more of it, using their limited income more fully.
    • A rise in the price of a good signals to producers that they should give away units for free.

14. A firm's profit falls because its costs rise faster than its prices. What is the signal and incentive that follow in a market?

    • Lower profit signals that consumers want more of the good, so output should rise immediately in the market.
    • Lower profit has no signal effect, since profit does not influence the allocation of resources in any market.
    • Lower profit signals reduced attraction to the market, so resources may move to more profitable uses over time.
    • Lower profit signals that the firm should expand, since low profit always encourages entry into the market.

15. Which of these is an example of the price mechanism rationing scarce tickets for a concert?

    • Tickets go to those who are willing to pay the highest price, leaving those unable to pay without tickets.
    • Tickets are given away free to all applicants, so there is no need for rationing in the market.
    • Tickets are allocated by a random lottery that takes no account of demand at the stated price.
    • Tickets are given to people who arrive first in the queue, regardless of their willingness to pay for them.

16. Which of these best illustrates the signalling function of the price mechanism in a global market for coffee beans?

    • Consumers in one country stop buying coffee, which raises prices for growers in every other country.
    • A government in one country sets a fixed price for coffee, which all other countries must then follow.
    • Coffee prices are the same everywhere, so no signals about scarcity are sent between different markets.
    • A poor harvest in one country raises world coffee prices, signalling to buyers and growers across the globe that supply is tight.

17. Explain why the price mechanism works more effectively in markets with many buyers and sellers.

    • Many buyers and sellers mean prices are fixed by the government, so the mechanism works without any competition.
    • Many competing buyers and sellers make prices reflect supply and demand, so price signals and rationing are more accurate.
    • Many buyers and sellers make the price mechanism irrelevant, since goods are allocated by the state in all cases.
    • Many buyers and sellers mean prices never change, since competition removes the signals that prices provide.

18. A local market for housing has a sudden inflow of new residents. Which price mechanism effects are most likely?

    • Rents and prices rise, rationing scarce homes, signalling higher demand and encouraging builders to supply more housing.
    • Prices fall, since new residents want to buy homes only when prices are at their lowest possible level.
    • Rents and prices fall, since new residents reduce the value of homes and so reduce the incentive to build.
    • Prices stay the same, since housing is always allocated by the state and never by the price mechanism.

19. Which of these best evaluates the price mechanism's ability to respond to changes in scarcity?

    • It responds quickly where markets are competitive, but it can be slow or distorted where information is poor or supply is inflexible.
    • It never responds to scarcity, since prices are fixed by producers regardless of demand in any market.
    • It responds only in local markets, since global prices cannot send any signals about scarcity at all.
    • It responds instantly and perfectly in every market, since prices always reflect all relevant information at once.

20. A price rise for a good leads to producers supplying more of it while consumers buy less. What is the economic function being shown?

    • Redistribution of income from consumers to producers, since the price rise transfers income from one group to the other.
    • A subsidy to consumers, since a higher price increases the amount of the good they can afford to buy.
    • The government setting a price, since the price rise is a result of a legal decision in the market.
    • The price mechanism allocating resources through rationing and providing an incentive for producers to supply more.

Related quizzes

• Economics as a social science Quiz · 1.1.1 · 20 questions
• Positive and normative economic statements Quiz · 1.1.2 · 20 questions
• The economic problem Quiz · 1.1.3 · 20 questions
• Production possibility frontiers Quiz · 1.1.4 · 20 questions
• Specialisation and the division of labour Quiz · 1.1.5 · 20 questions
• Free market, mixed and command economies Quiz · 1.1.6 · 20 questions
• Rational decision making Quiz · 1.2.1 · 20 questions
• Demand Quiz · 1.2.2 · 20 questions
• Price, income and cross elasticities of demand Quiz · 1.2.3 · 20 questions
• Supply Quiz · 1.2.4 · 20 questions