Functions of Price

Question 1

What is the 1st function?

Answer 1

the signalling function

Question 2

What does the signalling function do?

Answer 2

If demand is strong, this is a signal to suppliers to increase prices in order to clear the market - without a rise in prices, there would be excess demand (a shortage)

Question 3

What does the result of an increase in price result in?

Answer 3

this sends a signal to the producer to increase output - higher market prices act as an incentive to raise output because the supplier stands to make a higher profit (leading to an extension in supply)

Question 4

What is the 2nd function?

Answer 4

the rationing function

Question 5

What is the rationing function?

Answer 5

they ration scarce resources when demand in a market outstrips supply

Question 6

When there is a shortage of a product in the market…

Answer 6

…the price will rise, therefore deterring some consumers from purchasing the product

Question 7

What will happen when consumers lack the effective demand (i.e., purchasing power)?

Answer 7

they will be priced out of the market

Question 8

What is an example of the rationing function?

Answer 8

tolls (for roads) are a method of rationing scarce road space

Question 9

What is the 3rd funtion?

Answer 9

the incentive function

Question 10

What does the incentive function do?

Answer 10

low prices act as incentives to buyers - encouraging them to buy more goods, higher prices act as incentive for new firms to enter the market and increase supply - low prices discourage production