4.1.8.1 - How Markets and Prices allocate resources Flashcards
What are the precise functions that prices perform?
Signalling, Incentive, Rationing, Allocative.
What is the signalling function of prices?
Prices provide information to buyers and sellers and adjust to reflect scarcities and surpluses.
Give an example of the signalling function of prices?
The prices of graphics cards rising providing information to Nvidia to increase production.
What is the incentive function of prices?
Prices create a reason for people to alter their economic behaviour.
What is an example of the incentive function?
A higher price provides an incentive for people to alter their economic behaviour.
What is the rationing function of prices?
Increasing the price to reduce demand for a product.
Draw a graph demonstrating the incentive and rationing functions of prices?
(Typically a graph showing price increase leading to a decrease in demand with a shift in the quantity demanded).
What is an example of rationing and incentive functions?
Due to rising wages in a labour market, the demand for labour of a firm is rationed.
What is the allocative function of prices?
Changing relative prices allocate scarce resources away from markets with excess supply to those with excess demand.
What is the relationship between the rationing function of prices and allocative function of prices?
The allocative function of prices moves resources between markets, while the rationing function moves resources within markets to those who want them the most.
How do prices coordinate the decision making of buyers and sellers?
Through the incentive function of prices, and the rationing and allocative functions of prices.
What are the advantages of the price mechanism? (in competitive markets)
Promotes consumer sovereignty, productively efficient allocation of resources, and allocatively efficient allocation of resources.
How is consumer sovereignty a benefit of the price mechanism?
Goods and services are produced only if consumers ‘vote’ for them by spending on them.
How is a productively efficient allocation of resources a benefit of the price mechanism?
As the market is competitive, firms reduce costs to survive, and cost savings can be passed on to consumers.
How is allocative efficiency a benefit of the price mechanism?
Producers supply what society demands, ensuring no over- or under-consumption (though this is difficult to measure exactly).
What are the disadvantages of the price mechanism? (in imperfectly competitive markets)
Asymmetric market information, market power (promoting producer sovereignty), manipulation of consumer wants, and being ‘value-neutral.’
Why is asymmetric market information a disadvantage of the price mechanism?
Firms exploit producer sovereignty, meaning goods/services are determined by firms, not consumers.
Why is the manipulation of consumer wants a negative of the price mechanism?
Large, imperfectly competitive firms can manipulate consumer wants through persuasive advertising, making producers sovereign over consumers.
Why is the price mechanism being ‘value neutral’ a disadvantage of the price mechanism?
There is no regard for equality and allocation of buying power between different income groups, leading to market failures.
What is the case for extending the operation of the price mechanism?
Free marketeers believe the price mechanism works well, and government intervention often results in worse outcomes.
What is the case against extending the operation of the price mechanism?
Interventionists believe that markets often perform badly, and government intervention can improve outcomes.
