The market mechanism

What are the four functions of prices?

The signalling function, the incentive function, the rationing function and the allocative function.

What is the signalling function of prices?

Prices and changes in price signal/ provide information to consumers and producers of a good. E.g the relative quality of scarcity.

What is the incentive function of prices?

Prices incentivise and influence the decision of consumers and producers e.g a lower price encourages consumption but discourages production.

What is the rationing function of prices?

Rising prices ration demand for a product, the scare goods are distributed tho those who value them most highly.

What is the allocative function of prices?

Changing relative prices allocates scare resources away from markets exhibiting excess supply and into markets in which there is excess demand. (Directs recourses between markets.)

What are advantages of the price mechanism?

Promotes consumer sovereignty, leads to a productively efficient allocation of recourses, allocatively efficient outcome.

What are disadvantages of the price mechanism?

In imperfectly competitive markets, it leads to firms exploiting their producer sovereignty, producers may hold more power than consumers, the price mechanism is ‘value neutral’ (no regard for equality and fairness), can lead to market failure.