Price Mechanism Flashcards
What is the price mechanism
How resources are allocated in a free market through the use of the invisible hand of the market
Why do economists use the price mechanism
It is used to allocate scarce resources/ ration them
What does price signal
Consumers to consume
What does profit signal
Producers to produce
Price as a rationing device
This means that consumers that do not have the necessary level of income to pay market price will not consume
Rationing is best understood by referring to effective demand
Profit as a signal to producers
It is an incentive to produce, it is an effective way of determining what resources should be used and how best they should be used aswell as what is to be produced
How does price mechanism work
Prices increase if demand increases or supply decreases
Price decreases if demand decreases or supply increases
Does price mechanism ensure price stability
No that is the job of the government i.e. inflation
