Incentives
For competitive markets to work efficiently economic agents (i.e. consumers and producers) must respond to price signals in the market.
Price mechanism
The means by which decisions of consumers and businesses interact to determine the allocation of resources. The free-market price mechanism clearly does NOT ensure an equitable distribution of resources and can lead to market failure.
Price signals
Changes in price act as a signal about how resources should be allocated. A rise in price encourages producers to switch into making that good but encourages consumers to use an alternative substitute product (therefore rationing the product).
Rationing
A rising price can reduce the quantity demanded of a good or service.
Signalling
Prices have a signalling function because the price in a market sends important information to producers and consumers.
