5.1 How markets and prices allocate resources Flashcards
Prices allocate resources through the price functions which send messages to the market which is acted upon.
What are the four market functions?
Rationing function
Incentive function
Signalling function
Allocative function
What is the rationing function?
Excess demand for a good or service will lead to a rise in the price of a good or service
This is due to the scarcity of the product
The price rise will lead to a reduction in demand
What is the incentive function?
Higher prices act as a motivator for producers to increase the supply of a good or service
This is due to greater contribution per unit i.e. the difference between selling price and variable cost
As prices rise so do revenue and profit
What is the signaling function?
An increase in price will give an indication to producers that they should increase supply
An increase in price will give an indication to consumers that they should reduce demand
A decrease in price will give an indication to producers that they should decrease supply
A decrease in price will give an indication to consumers that they should increase demand
What is the allocative function?
Allocative function acts to divert resources to where they can maximise their returns and away from uses where they don’t
What is economic efficiency?
Economic efficiency occurs when the maximum amount of products are produced at their minimum cost whilst maximising their benefit to society
What is allocative efficiency?
Allocative efficiency occurs where consumer satisfaction is maximised in the production of goods and services, goods produced match the needs of consumers
What is productive efficiency?
Productive efficiency occurs where no additional (or maximum) output can be produced from the factor inputs available at the lowest possible average or unit cost, minimum inputs to produce the maximum output at the lowest cost
