4.1.8.1 How markets and prices allocate resources Flashcards
What is the price mechanism?
The ‘invisible hand’ (Adam Smith) that allocates scarce resources in a free market.
Solves the economic problem by adjusting prices to balance supply and demand.
How does price ration resources?
Scarcity → price ↑ → demand ↓ (e.g., plane tickets rise as seats sell out).
Example: Surge pricing for Uber during peak times.
How do prices incentivize producers/consumers?
High price: Encourages firms to supply more (profit motive).
Low price: Encourages consumers to buy more.
Example: High smartphone prices → more firms enter market.
What signals do prices send?
High price: Signals resource shortage → firms enter market.
Low price: Signals surplus → firms exit.
Example: Rising oil prices signal need for alternative energy.
List 3 advantages of the price mechanism.
Efficiency: Resources allocated to most valued uses.
Consumer sovereignty: Spending ‘votes’ determine production.
Automatic adjustment: No central planning needed.
List 3 disadvantages of the price mechanism.
Inequality: Only those with income can participate.
Public goods underprovided: No profit incentive (e.g., lighthouses).
Merit goods ignored: Education/healthcare underconsumed.
Why is introducing markets into some areas controversial?
Moral hazard: Markets may corrupt altruism (e.g., blood donations → paid systems reduce voluntary supply).
Example: UK’s voluntary blood system vs. paid systems elsewhere.
How does the price mechanism worsen inequality?
‘Spending votes’ favor the wealthy → poor excluded from markets.
Example: Luxury housing built while homeless lack shelter.
When is government intervention needed?
Public goods: Defense, street lighting.
Merit goods: Subsidized education/vaccines.
Externalities: Pollution taxes.
Draw a S/D diagram showing price rationing during scarcity.
Demand > Supply → Price rises to P₁ → Qᴅ decreases to Qₛ.
Is the price mechanism fair?
Yes: Rewards efficiency/innovation.
No: Ignores equity; perpetuates poverty cycles.
Give an example of price signalling in action.
Electric cars: High oil prices → investment in renewables.
