Price Mechanism Flashcards
Price mechanism refers to?
the interactions between buyers and sellers in the free market in order to allocate resources, thereby determining production and consumption choices.
Explain the rationing function of the price mechanism
The rationing function of the price mechanism deters some consumers from buying a product or resource owing to higher prices, thereby rationing (preserving) it.
It serves to ration scarce resources when the demand for a product exceeds its supply.
Explain the signalling function of the price mechanism
The signalling function is an aspect of price mechanism in allocating resources by providing information to producers and consumers where resources are required and where they are not required.
Explain the incentive function of the price mechanism
The incentive function is an aspect of the price mechanism in allocating resources as price changes provide an incentive for producer and consumers to change their behaviour in order to maximize their benefits.
How does the signalling and incentive function of price mechanism increase resource allocation
The signalling and incentive function of price increases the resources allocated given that a rise in the market price of a good or service, sends a signal to potential firms to enter the industry. As a result of the increased number of firms in the market, the supply curve of the product would shift outwards to the right since there will be a greater number of firms supplying more amount of output. Hence, increasing the resources allocated in the market.
Moreover, higher prices act as an incentive for existing suppliers to raise output owing to the higher profit margins and sales revenue. Thus, the increased output increases the resources allocated in the market.
