Economy Answer to an Ib Paper 1 Question
Written by: Sevdenur Tural
Explanation: This text is an answer for a SL paper 1 question from May 2007 session.
PRICE MECHANISM
Explain the signaling and incentive functions of price in a market economy. In free Market economy allocation of resources is left to market forces of supply and demand which also can be referred to as price mechanism. And the prices are determined as a result of the interaction of those market forces. Price mechanism enables the market to move to equilibrium, if left to act alone. When demand curve shifts to left due to a non-price factor such as change in tastes, the equilibrium price will increase. Increasing prices is the signal for the producers and shows the willingness and ability of consumers to buy it more. This will serve as an incentive to producers to allocate their resources more on that specific product since now it is more profitable owing to its increasing prices. However, as the resources for that production is being used up more and more, they will become scarce eventually leading to shift of supply curve to the left which will push the prices up. This case corresponds to a downward movement along the demand curve as the price increase acts as a signal to consumer to lower their consumption.
INTERVENING to a MARKET of a DEMERIT GOOD
Evaluate the proposition that government intervention in the market for Tobacco is justified. Tobacco is a demerit good which costs more than what people may be aware of. So if left to the market forces they are overproduced. Actual optimum level of output for tobacco is misled due to its negative externalities of consumption. When the figure is drawn according to the MPB (marginal private cost), the curve will reflect the benefits that are enjoyed only by the consumers of that product. On the other hand, when we consider the third parties as well and draw the suitable MSB (marginal social cost) curve, it will be below the MPB curve which means that total
Explanation: This text is an answer for a SL paper 1 question from May 2007 session.
PRICE MECHANISM
Explain the signaling and incentive functions of price in a market economy. In free Market economy allocation of resources is left to market forces of supply and demand which also can be referred to as price mechanism. And the prices are determined as a result of the interaction of those market forces. Price mechanism enables the market to move to equilibrium, if left to act alone. When demand curve shifts to left due to a non-price factor such as change in tastes, the equilibrium price will increase. Increasing prices is the signal for the producers and shows the willingness and ability of consumers to buy it more. This will serve as an incentive to producers to allocate their resources more on that specific product since now it is more profitable owing to its increasing prices. However, as the resources for that production is being used up more and more, they will become scarce eventually leading to shift of supply curve to the left which will push the prices up. This case corresponds to a downward movement along the demand curve as the price increase acts as a signal to consumer to lower their consumption.
INTERVENING to a MARKET of a DEMERIT GOOD
Evaluate the proposition that government intervention in the market for Tobacco is justified. Tobacco is a demerit good which costs more than what people may be aware of. So if left to the market forces they are overproduced. Actual optimum level of output for tobacco is misled due to its negative externalities of consumption. When the figure is drawn according to the MPB (marginal private cost), the curve will reflect the benefits that are enjoyed only by the consumers of that product. On the other hand, when we consider the third parties as well and draw the suitable MSB (marginal social cost) curve, it will be below the MPB curve which means that total