The Price Mechanism Flashcards
How is price a market signal?
It guides businesses on how to use available resources, as they want to sell at a high price in order to do what is profitable.
How do prices act as a rationing device?
Because only those willing and able to pay will get the product and service
How does price act as an incentive?
Because profitability motivates firms, and value for money motivates customers
State and describe the three price mechanism functions
- signalling - prices give signals to produce and consumers
- rationing - only those willing and able to pay get the product or service
- incentives - profit motivates firms, and value for money motivates consumers
State the two advantages of the price mechanism
- it works automatically, following decisions taken by a multitude of economic agents
- it can direct resources to the best possible use
What are economic models?
Use simplified assumptions to explain economic relationships. This allows us to isolate individual changes and analyse their consequences, avoiding the complications that occur when several things are changing at once. There success depends on how realistic the assumptions are.
What is the allocation of resources
Reflects the way in which economic agents take decisions about what to buy, what to produce and how best to use available land, labour and capital
What is the price mechanism?
An economic model that helps explain the allocation of resources between different possible uses. It shows how the invisible hand guides resources towards the production of what consumers will buy
State the weaknesses of the price mechanism
- reasonable assumptions may not always be realistic. The assumption that consumers act in a rational way may not always prove to be true
- The price mechanism makes no reference to inform redistribution. Wealth accumulates in the hands of the super rich. This means the spending decisions that determine resource use are dominated by the super rich. The price mechanism sheds no light on this
