Price Mechanism Flashcards
What is the price mechanism
The decisions taken by consumers and businesses interact to determine the allocation of scare resources between competing uses
What are the 3 main functions of the price mechanism
Signalling Function
Incentivising Function
Rationing Function
What is the signalling function
Prices adjust to demonstrate where resources are required
Prices rise and fall to reflect scarcities and surpluses
What happens when prices are rising due to high demand
Signalling function is in action
Signal to suppliers to expand production to meet the higher demand
What happens when there is excess supply in the market
Signalling function is in action
Market price will fall to eliminate a surplus of a good
What is the incentive function
Consumers send information to producers about their changing nature of needs and wants through their choices
What does the price mechanism do with higher prices
Incentive function is in action
Incentivises producers to raise outputs to make more profit
What happens when demand is weaker in a recession
Incentive function is in play
Supply contracts as producers reduce their output
What is the rationing function
When prices ration scarce resources due to excess demand
What happens when there is a shortage in supply
Rationing function is in play
Prices are higher so people who are only willing and able to pay can buy
What must happen for competitive markets to work efficiently
All agents must respond to appropriate price signals in the market
When does market failure occur
When signalling and incentive functions fail to operate optimally which leads to a loss of economic and social welfare
What can change incentives for consumers and producers
Government intervention
