price mechanism

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 f resources and can lead to market failure

changes in market prices

- act as a signal
- rise in price: encourages producers to switch to making that good and encourages consumers to use an alternative substitute product
- fall in price -> extension of demand but makes it less profitable

main functions of the price mechanism

- signalling function
- incentive function
- rationing function

signalling function

prices rise and fall to reflect scarcities and surpluses

incentive function

through choices consumers send information to producers about their changing needs and wants; prices provide incentive to consumers and producers to use resources in the most effective way

rationing function

Prices ration scarce resources when demand outstrips supply; when there is a shortage, price is bid up

market types and the price mechanism

- local markets
- national markets
- global markets

local markets

- hairdressers, cafes: if there is excess demand consumers can switch to substitutes ????

national markets

- e.g. housing market: as scarcity increases, prices have increased to ration this demand

global markets

e.g. oil
can impact the macroeconomy