1.2.7 Price Mechanism

Question 1

What does Adam Smith believe in

Answer 1

-A free market (the prices mechanism allocates resources efficiently)
-He described how the invisible hand of the market operated in a competitive market through the pursuit of self interest to allocate resources in societies best interests

Question 2

What is the price mechanism

Answer 2

The idea that the millions of decisions made by consumers and producers interact to determine the allocation of resources

Question 3

What are the functions of price

Answer 3

Rationing, incentive and signalling

Question 4

What is rationing

Answer 4

-Wants are infinite but resources are scare so need to be allocated between competing uses
-If demand is high and supply low a high price will mean supply is rationed to buyers willing and able to buy at the highest price
(Who values it the highest)

Question 5

What is incentive

Answer 5

-When price rises it creates an incentive for firms to shift production for profit
-When price falls it creates an incentive for firms to move away from production of that product

Question 6

What is signalling

Answer 6

-Market prices adjust to demonstrate where resources are and aren’t required
-Prices rise and fall to reflect scarcities and surpluses and to provide incentives to economic agents