Price Mechanisms

What is the price mechanism?

The price mechanism determines the market price by allocating resources in a free market economy through changes in price.

How does the price mechanism solve the problem of scarce resources?

The price mechanism moves resources to where they are demanded or in shortage and removes them from where there is a surplus.

What are the three main functions of the price mechanism?

• Rationing – Higher prices ration scarce resources by discouraging demand.

• Incentive – Higher prices encourage producers to supply more because of higher profitability.

• Signalling – Prices signal firms and consumers about resource needs in the market.

How does the rationing function work?

When resources are scarce, prices rise due to high demand, discouraging some consumers from purchasing, thereby rationing the resources.

Give an example of the rationing function in action.

Plane tickets increase in price as seats sell out, discouraging further demand.

How does the incentive function influence producers?

Higher prices encourage firms to produce more because it becomes more profitable.

How does the price mechanism act as a signal?

A high price signals firms to enter a market because of profitability, while also encouraging consumers to reduce demand.

What is a mass market?

A large market with a broad consumer base, such as restaurants in general.

What is a niche market?

A smaller market focused on specific consumer needs, such as Italian cuisine.

How does the price mechanism allocate resources in niche markets?

It allocates resources more efficiently because niche markets directly target consumer preferences, leading to higher profitability and better allocation.

Why might niche markets be more profitable than mass markets?

Because they directly target consumer needs, leading to higher demand and more efficient resource allocation.