1.2.7: Price Mechanism Flashcards
In a ________ ________ ________, the price mechanism allocates resources.
Free market economy.
What is price mechanism?
The system where the forces of demand and supply determine the prices of commodities.
What are the three functions of the price mechanism?
•Rationing.
•Signalling.
•Incentive.
What is the rationing function?
•People ration scarce resources when demand outstrips supply.
•When there is a shortage, price is raised, leaving only those with willingness and ability to buy.
What is the signalling function?
•A signal as to where resources should be allocated.
•If prices are rising due to high demand, it is a signal to suppliers to expand production.
•If there is excess supply, the price mechanism helps to eliminate surpluses by allowing the market price to fall.
What is the incentive function?
•Consumers show their changing wants and needs through choices.
•Low prices are an incentive for consumers to buy more of a good.
•High prices are an incentive for suppliers to sell more of a good.
What is the context for local markets (price mechanism)?
The COVID-19 pandemic disrupted supply chains globally. In British supermarkets, demand for food was high, but supply was low. Prices rose to ration off excess demand so that only people who value the food most highly buy them.
Rationing function.
What is the context for national markets (price mechanism)?
The price for housing in the UK differs (higher in the south than the north). London- as the capital city and the second largest financial centre in the world- has a high population density compared to the rest of the UK. House prices rise to ration off excess demand (rationing function), and to offer an incentive for firms to allocate resources to house production.
Incentive function.
What is the context for global markets (price mechanism)?
In 1973, the OPEC issued an oil embargo, sending the price of oil at record-breaking levels globally.
Rationing function.
