price mechanisms

• 3 functions of the price mechanism

  1. Rationing
  2. Signaling
  3. Incentivising
• Excess demand


  More demand than supply available
• Rationing

  1. When there is not enough supply to meet demand
  2. price gets bid up due to scarcity
  3. Quantity demanded increases price
• Signaling

  1. when a change in price signals to consumers/producers to demand/supply more or less
• Incentivising

  1. when there is an incentive to increase or decrease demand/supply due to utility/profit maximisation
  2. Quantity supplied to quantity
• Evaluations to rationing

  1. If it is a necessity eg water
  2. Products that lack available substitutes
  3. Veblen effect- increase in price sometimes leads to an increase in demand eg company shares
  4. Products that cost a small proportion of consumer income
• Evaluations to signaling

  1. Government intervention
• when discussing a change in price

  mention the price mechanisms : rationing, signaling, incentivising
• Evaluations to the incentive function

  1. Lack of spare capacity( CLL) to supply more despite an increase in price
  2. Costs of production may be too high (taxes)
  3. Regulations on emissions or working hours may prevent increasing supply
  4. Time lag in production process (agricultural goods take time to grow)