1.2.7 Price mechanism

Functions of the price mechanism to allocate resources: rationing

When there are scarce resources, price increases due to the excess of demand. Increase in price discourages demand and consequently rations resources.

Functions of the price mechanism to allocate resources: incentive

Encourages a change in behaviour of a consumer or producer. E.g high price would encourage firms to supply more to the market as this is profitable

Functions of the price mechanism to allocate resources: signalling

Price acts as a signal to consumers and new firms entering the market. High price signals firms to enter the market because its profitable. However this encourages consumers to reduce demand and therefore leave the market

The price mechanism in context of local markets

The COVID pandemic disrupted supply chains across the planet. Many countries blocked imports to prevent spread of virus. As demand for food is high but supply is low, the price of food rises to ration off excess demand so only consumers who value the food most highly buy.

The price mechanism in context of national markets

Price of housing differs in the UK and reasons for this include population, finance and tourism (such as london) House prices will rise through the rationing function and the high house prices offer an incentive for firms to allocate resources to the production of more houses as there is profit to be made which is the incentive function

The price mechanism in context of global markets

1973 and oil embargo was proclaimed due to geopolitical factors which sent price of oil to record breaking levels across the planet. This exemplifies the rationing function ad the disequilibrium of supply and demand meant the high prices deterred consumers who didn’t value oil highly. By raising price of oil, market returned to state of equilibrium.