1.2.7 Price Mechanism

Question 1

What are the three functions in the Price Mechanism?

Answer 1

The rationing function

The signialling function

The incentive function

Question 2

What is the rationing function?

Answer 2

When price increases, demand drops as people cant or dont have the desire to buy the good anymore.

The limited resources can be rationed and allocated to the people who are able to afford them and those who value them the most highly.

Question 3

What is the signalling function?

Answer 3

The price mechanism acts as a signal where resources should be used.

When prices rise, producers move resources into producing more of that product.

The change in price indicates to suppliers and consumers that market conditions have changed so they should change the qty bought and sold.

Question 4

What is the incentive function?

Answer 4

Buyers realise that the more money they have the more products they can buy.

Suppliers realise if they can produce more of the good, they can make more money.

Low prices = incentive for consumers to buy more of a good.
High prices = incentive for suppliers to sell more of a good.