Price Mechanism- 4 Functions-Signal, Incentivise, Ration, Allocate Flashcards
(10 cards)
What is the Price Mechanism?
The price mechanism is how prices in a free market allocate resources without government intervention, based on the interaction of supply and demand.
What does ARSI stand for in the Price Mechanism?
Allocate: Resources go to the most valued uses.
Ration: Prices rise to reduce excess demand.
Signal: Prices rise or fall to signal shortages or surpluses.
Incentivise: Higher prices incentivise producers to produce more and vice versa.
What happens when demand shifts to the right (e.g., due to PASIFIC)?
Price increases and quantity increases.
Shortage (excess demand) at original price.
ARSI functions kick in:
Signals producers of high demand.
Incentivises more supply.
Rations consumption.
Allocates scarce goods more efficiently.
What happens when supply shifts to the right (e.g., due to PINTSWC)?
Price decreases and quantity increases.
Surplus resolved as:
Lower prices signal excess supply.
Consumers incentivised to buy more.
Resources reallocated to other sectors.
Leads to new equilibrium at lower price and higher quantity.
What is the result of the price mechanism functioning correctly?
Market returns to equilibrium, achieving allocative efficiency — resources are used where they are most valued by society.
What happens when there is excess supply at price P?
Supply > Demand (e.g., Qs > Qd).
Surplus in the market (unsold stock, empty tables, overproduction).
This puts downward pressure on price.
What happens when price falls from P to P2 due to excess supply?
ARSI functions kick in:
Allocate: Resources shift out of oversupplied market.
Ration: Lower price encourages more demand.
Signal: Signals surplus to producers and consumers.
Incentivise: Producers reduce output; consumers buy more.
Result: Market returns to equilibrium (Q2).
What does a contraction along the supply curve represent?
Producers reduce output in response to falling prices.
May involve firms exiting the market or cutting capacity.
What does an expansion along the demand curve represent?
Consumers increase demand due to lower prices.
Helps absorb the surplus.
What happens when both demand and supply shift to the left?
Demand decrease: less quantity bought at any price.
Supply decrease: less quantity produced at any price.
New equilibrium will depend on the size of each shift.
Likely results in lower quantity and possibly price change.
