Price Mechanism

Question 1

Incentives

Answer 1

For competitive markets to work efficiently economic agents (i.e. consumers and producers) must respond to price signals in the market.

Question 2

Price mechanism

Answer 2

The means by which decisions of consumers and businesses interact to determine the allocation of resources. The free-market price mechanism clearly does NOT ensure an equitable distribution of resources and can lead to market failure.

Question 3

Price signals

Answer 3

Changes in price act as a signal about how resources should be allocated. A rise in price encourages producers to switch into making that good but encourages consumers to use an alternative substitute product (therefore rationing the product).

Question 4

Rationing

Answer 4

A rising price can reduce the quantity demanded of a good or service.

Question 5

Signalling

Answer 5

Prices have a signalling function because the price in a market sends important information to producers and consumers.