8.1 How Markets and Prices Allocate Resources

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6 Terms

1
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What are the three main functions of the price mechanism in resource allocation

Rationing, incentive, and signalling

2
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How does the rationing function of the price mechanism work

It determines how scarce resources are distributed among competing uses based on price levels

3
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What is the incentive function

Higher prices provide an incentive to producers to increase supply due to potential higher profits

4
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What is the signalling function

Prices signal to consumers and producers about the relative scarcity or abundance of goods and help guide their economic decisions

5
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What are the advantages of the price mechanism

  • Efficient resource allocation

  • Consumer power

  • Responsiveness to changes in demand and supply

6
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Disadvantages of the price mechanism

  • May lead to inequality

  • Under-provision of public goods

  • Failure to account for externalities