The Price Mechanism

Question 1

Functions

Answer 1

• Determines the market price
• Resources are allocated though the price mechanism in a free market economy.
• The economic problem of scarce resources is solved by this.
• The price moved to where there is demand or where there is a shortage.
• Removes resources from where there is a surplus.

Question 2

The three main functions

Answer 2

Rationing
Incentive
Signalling

Question 3

Rationing

Answer 3

• When there are scarce resources, price increases due to excess demand.
• Increase in price discourages demand and consequently rations resources.

Question 4

Incentive

Answer 4

• This encourages a change in the behaviour of consumers or producer
• For example; a high price would encourage firms to supply more to the market (more profitable to do so)

Question 5

Signalling

Answer 5

• Acts as a signal to consumers and new firms entering the market.
• Price changes show where resources are needed.
• An increase in price signals to firms to enter the market - but this reduces demand and consumers leave the market.