1.3.4 price mechanism Flashcards
(9 cards)
What does the price mechanism do? What did Adam Smith call this?
It determines the market price, Smith calling it ‘the invisible hand of the market’.
What economic problem does price mechanism solve?
Scarcity, as resources are allocated through the price mechanism.
Price moves resources to where they are demanded or where there is a shortage, and removes resources from where there is a surplus.
What are the 3 different price mechanism functions?
- Rationing
- Incentive
- Signalling
What is rationing function?
When there are scarce resources, price increases due to excess of demand. Increase in price discourages demand and consequently rations resources.
For example, plane tickets might rise as seats are sold, because spaces are running out. This is a disincentive to purchase the tickets, which rations the tickets.
What is incentive function?
This encourages a change in behaviour of a consumer or producer. For example, a high price would encourage firms to supply more to the market, because it is more profitable to do so.
What is signalling function?
Acts as a signal to consumers and new firms entering the market. The price changes show where resources are needed in the market. A high price signals firms to enter the market because it is profitable.
However, this encourages consumers to reduce demand and therefore leave the market. This shifts the demand and supply curves.
What is a mass market?
The largest group of consumers for a product, such as restaurants.
What is a niche market?
A smaller market, where a specific product is focused on. For example, it might be a particular cuisine, such as Italian.
Why are niche markets generally better at allocating resources?
As they are closer to the consumer, and allocate them better to what consumers want.
Consumers are targeted directly rather than generally, making allocation of resources more efficient.
