Price Mechanism Flashcards
Adam Smith
The ‘invisible hand of the price mechanism’
What are the three functions of price
Signalling
Rationing
Incentive
Rationing function of price
They ration scarce resources when demand outstrips supply
In a command economy who directs scarce resources
The planning mechanism directs scarce resources to where the state thinks there is the greatest need
When does market failure occur
When the signalling and incentive functions of the price mechanism fail to operate optimally leading to a loss of economic and social welfare
What is needed for competitive markets to work efficiently
All ‘economic agents’ (consumers and producers) must respond to appropriate price signals in the market
Signalling function of price
Changes in price provide information to both producers and consumers about changes in market conditions
When do secondary markets occur
When buyers and sellers are prepared to use a second market to re-sell items that have already been purchased
How are the price incentives that consumers and producers have changed
By government intervention e.g. prices can change through government subsidies and taxation (law of unintended consequences)
