1.2.7 Price mechanism

Question 1

What are price mechanisms?

Answer 1

The price mechanism is the interaction of demand and supply in a free market. This interaction determines prices which are the means by which scarce resources are allocated between competing wants/needs.

Question 2

What are the three functions in the relationship between buyers and sellers?

Answer 2

/Rationing
/Signalling
/Incentive

Question 3

Explain the function rationing?

Answer 3

Rationing: prices allocate (ration) scarce resources. When resources become scarcer the price will rise further. Only those who can afford to pay for them will receive them. If there is a surplus then prices fall and more consumers can afford them.

Question 4

Explain the function signalling?

Answer 4

Signalling: prices provide information to producers & consumers where resources are required (in markets where prices increase) & where they are not (in markets where prices fall).

Question 5

Explain the function incentive?

Answer 5

Incentive: when prices for a good/service rise, it incentivises producers to reallocate resources from a less profitable market to this market in order to maximise their profits. Falling prices incentivise reallocation of resources to new markets.