1.16 Price Mechanism

Question 1

What is the price mechanism?

Answer 1

It is how prices allocate goods and services in a market based on the levels of demand and supply

Question 2

What are the 3 functions of the price mechanism?

Answer 2

• signalling
• incentive
• rationing

Question 3

What is the signalling function?

Answer 3

This is where prices change to demonstrate where resources are required. A price rise will signal the producers that they should make more of this product

Question 4

What is the incentive function?

Answer 4

An incentive is something that motivates a producer or consumer to follow a course of action or to change behaviour.
Higher prices provide an incentive to producers to supply more because they provide the possibility of more revenue and increased profit

Question 5

What is the rationing function?

Answer 5

Done to ensure the proper distribution of resources without any unwanted waste.
If demand > supply, price rises so rationed to those who can afford to pay

Question 6

Elastic / inelastic price and revenue

Answer 6

• When demand is price elastic a decrease in price results in a rise in total revenue.
• When demand is price inelastic a decrease in price results in a decrease in total revenue.
• When demand is price elastic an increase in price results in a decrease in total revenue.
• When demand is price inelastic an increase in price results in a rise in total revenue.