How Markets And Prices Allocate Resources Flashcards
What is the price mechanism
How free markets allocate resources
An increase in demand raises prices and encourages businesses to put more resources into production
What are the 4 key functions in the price mechanism
Signalling
Incentive
Rationing
Allocative
What is the signalling function
Where prices provide important market signals to buyers and sellars
Changes in price provide information about market conditions
What does a rise in price indicate in the signalling function
That demand is greater than supply
What do falling prices indicate in the signalling function
Supply is greater than demand
What is the incentive function
Where increased prices strengthen incentives to firms to produce more in order to make a profit
What to rising prices mean in the incentive function
Means that firms are incentivised to extend supply
What do falling prices mean for firms in the incentive function
That firms are incentivised to contract supply
What is the rationing function
When consumers have a set amount of disposable income so as price changes consumers have to decide how to spend their money
What do rising prices in the rationing function show
Shows that consumers will ratio and demand contracts
What do falling prices in the rationing function mean
That consumers unration and demand extends
How do the functions of price help to allocative resources when there is an increase in demand ?
Signalling function- excess demand signals or suppliers that price is too low and needs to rise
Incentive function - higher price means a change to make a higher profit , so supply extends
Rationing function- as prices rise, demand contracts
How do all of the functions of price help to allocate resources when there is a fall in demand
Signalling - excess supply signals that price is too high and needs to fall
Incentive- a lower price means that there is less chance or make a higher profit to supply contracts
Rationing- as prices fall, demand extends
How do the functions of price help to allocate resources when there is an increase in supply
Signalling - excess supply signals to suppliers that price is too high and needs to fall
Incentive- falling price means less chance to make a higher profit so supply contracts
Rationing- as price falls, demand extends
How do the functions of price help to allocate resources when there is a decrease in supply
Signalling- excess demand signals to suppliers that price is too low and needs to rise
Incentive- a rising price means more chance to make a higher profit so supply extends
Rationing - as prices rise- demand contracts
