5. Why do prices act as signals to buyers and sellers?

One of the things that prices do is carry information to buyers and sellers. Low prices are signals to buyers (consumers), who can now afford to purchase the things they want. When prices are high enough, they send a signal to sellers (producers), who can now earn a profit at the new price. Acting in accordance with the profit motive, business firms produce what the consumers desire.

6. What is the producers’ main incentive?

Lower prices means that firms begin to produce less. Higher prices means that firms begin to produce more. So the price is the producers’ main incentive.

7. Why does the price system determine each person’s income?

The price system determines how society’s output will be distributed among the people. Finally, prices help to determine who will receive the nation's output of goods and services. Under the price system, each person’s income is determined in the market place. Some people are endowed with talent, skill, intelligence, education or special training and earn more, on the average, than those who are not endowed with such qualities.

8. What is an equilibrium price?

One of the functions of markets is to find equilibrium prices that balance the supply of and demand for goods and services. An equilibrium price (also known as a market price) is one at which each producer can sell all he wants to produce and each consumer can buy all he demands.

9. What is excess supply?

At prices above the equilibrium price, the quantity supplied exceeds the quantity demanded, so a surplus or excess supply develops. When the quantity supplied by firms is greater than the quantity demanded by consumers there is more being produced than is being consumed.

10. What is a shortage and when does it develop?

At prices below the equilibrium price, the quantity demanded is greater than the quantity supplied, and a shortage or excess demand develops. Shortage can be eliminated by allowing prices to rise to the equilibrium level. The increased quantity demanded is a signal to firms to raise prices. With higher prices the quantity demanded declines and firms are motivated by the higher prices to produce more, which returns the market to equilibrium.

11. What does a decrease in demand lead to?

The increased quantity demanded is a signal to firms to raise prices. With higher prices the quantity demanded declines and firms are motivated by the higher prices to produce more, which returns the market to equilibrium.

12. What does an increase in supply result in?

If the change in supply increases supply, you will see the supply curve shift to the right.