8.1 - Markets and allocation of resources, 8.2 - market failure Flashcards
What is the signalling function of prices?
prices provide information to buyers and sellers
what are the 4 functions of prices?
- signalling
- incentive
- rationing
- allocative
what is an example for the signalling function of prices?
if fresh fruit or produce is cheap, it could be a sign that it won’t last very long or is of poor quality
what is the incentive function of prices?
creates incentives for people to alter economic behaviour
what is an example of incentive function of prices?
if the market price for a good is high, more firms will either join the market or will be willing to produce more (S –> S1)
What is the rationing function of prices?
rising prices ration demand for a product
What is an example of the rationing function of prices? (ie rise in price…)
a rise in price will create incentive for firms but will RATION demand.
ration demand - price rise will get rid of excess demand as demand contracts until the excess is eliminated
What is the allocative function of prices?
changing relative prices to allocate scarce resources away from markets that exhibit excess supply and into markets which have excess demand
What is an example of the allocative function of prices?
if there’s a high price in the market for bikes, firms will allocated their resources (factors of production) away from their current market where there may be excess supply to this one where there is excess demand (seen because of the high price, shortage of good in market)
What is highly competitive market also known as?
perfect competition
How to prices affect allocation in a perfect competition market?
firms and consumers will passively accept the market prices set by supply and demand (invisible hand)
what is the invisible hand?
how free markets can motivate individuals, acting in their own self-interest, to produce what is societally necessary
who came up with invisible hand?
Adam smith
in a market economy, what allocates resources?
- prices and markets alone allocate resources
How do prices coordinate the decision making or buyers/sellers in a MIXED economy?
responds to the incentive function of prices which leads to the rationing and allocative function as well
What is the assumption made for consumers when purchasing goods?
consumers buy from sellers who charge at the lowest price
What is the assumption made for producers when producing a good?
- use most efficient methods of production in order to cut costs and achieve business profit maximisation
- move their resources from one market to another if there is a higher price
- takes place automatically with the invisible hand
What are the advantages of the price mechanism, (to allocate resources)?
- consumer sovereignty is promoted, (as firms that do not produce these goods, will not survive in perfect competition/highly competitive)
- if it works, creates a productively efficient allocation of resources, cost reduction price mechanism
- more allocatively efficient as it is producing more of the good that people want to buy
What is consumer sovereignty?
where consumers, through purchasing decisions, have a powerful influence on what is produced
- this is because they make up the demand
What is allocative efficiency?
occurs when it is impossible to improve overall economic welfare by reallocating resources between markets.
What is productive efficiency?
when is is impossible to produce more of one good without less of the other
What are the disadvantages of the price mechanism?
- there’s ASYMMETRIC market information and market POWER which could lead to producer sovereignty. Here, producers will exploit this and the goods and services are determined by firms rather than consumer preferences
- value neutral - no regard for equality, marginalised groups…
- could lead to market failures
What is the case for privatisation?
the government failure can be worse than the effects of the price mechanism
What is the case against privatisation?
markets perform badly, government intervention is needed to help the price mechanism
