The Market Mechanism, Market Failure and Government Intervention

Question 1

What are the functions of price in a competitive market?

Answer 1

• Rationing function: It is not possible to satisfy unlimited wants of consumers with scarce resources. Prices acts as a rationing function as only those prepared to pay market price are able to purchase.
• Incentive function: Low prices incentivise consumers to buy more, to increase their satisfaction. High prices incentivise suppliers to produce more, to increase their profit.
• Signalling function: Price signals whether it is worthwhile to buy or sell a product. If consumers want more, demand and thus price increase. This encourages suppliers to make more of that product.