LS16 - Price Mechanism

Question 1

Price Mechanism

Answer 1

Allocates resources between conflicting uses. Demand and supply fix the price at which exchange takes place - it has 3 functions.

Question 2

Rationing Function

Answer 2

Allocates and rations scarce resources - if there’s low supply and high demand, only those that can afford it will buy it.

Question 3

Signalling Function

Answer 3

Prices reflect market conditions and act as a signal to people in the market, they base decisions of buying and selling on those signals - price changes signal to both buyers and sellers they should change the amount bought/sold.

Question 4

Incentive Function (Buyers)

Answer 4

Low prices encourage buyers to purchase more goods, because the amount of utility gained per £ spent increases relative other goods. Higher prices discourage buying because less consumers get fewer goods per dollar spent.

Question 5

Incentive Function (Sellers)

Answer 5

Higher prices encourage suppliers to sell more to the market, meaning they may have to invest in themselves. Lower prices discourage production, as it’s no longer profitable (is less profitable).