Cambridge International as and a level Economics Ebook

SELF-ASSESSMENT TASK 
2.23
On 1 May 2009, the price of white sugar on the 
London commodity market reached a two-and-a-
half-year high of $441 per tonne. Analysts put this 
down to an increase in demand from India, the 
world’s largest consumer, and from Russia. A heft y 
850,000 tonnes was heading for these two markets in 
May. With the imminent peak in the Brazilian cane 
harvest, it was expected that the increase in supply 
would bring prices down.
1
Using demand and supply diagrams:
a
Show how the increase in demand from India 
and Russia aff ected the market.
b
Show how the increased supply of Brazilian 
sugar might aff ect the market.
2
What factors might mean that the world price of 
sugar will continue to increase in the future?
The workings of the price 
mechanism – final thoughts
It should be clear from this chapter that prices have a very 
important role in the allocation of resources in the market 
economy. Th
e price mechanism works automatically: this 
was referred to by Adam Smith two centuries ago as ‘the 
invisible hand’. Th
e principles behind this process remain 
good today.
Prices act as a signal
 
to both producers and consumers. 
A rise in the quantity demanded results in an increase in 
price, signalling to producers that they should put more 
of their products onto the market. In turn, if consumers 
withhold their demand, prices can be expected to fall. Th
is 
signals that less should be produced. Th
e price mechanism 
works in such a way that the outcome is a new equilibrium 
position with consumers’ demand equal to producers’ 
supply.
In other situations, the price system can ration 
products in the market. Th
is process is also automatic. 
For example, a producer may wish to limit the supply of 
products to retain their exclusivity in the market. Th
ese 
products are likely to have a high price, as in the case of 
exclusive jewellery or top of the range sports cars; a form 
of rationing takes place because of the high price. Th
is 
limits demand and, in turn, ensures that it is in line with 
the quantity supplied to the market.
It should be clear that the price mechanism allows 
the preferences of consumers to be made known to 
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Figure 2.17 
The eff ect of a shift in the supply curve on 
equilibrium price and quantity
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