How markets and prices allocate resources

• What are some of the advantages of Price Mechanism?

  • Promotes consumer sovereignty - consumers hold most power in the relationship
  • Leads to be productive/ allocative efficiency
• What are some of the disadvantages of Price Mechanism?

  • Imperfect info affects both firms and consumers
  • In monopolies, firms exploit price mechanism taking away consumer spending power
  • Goods and services consumed are determined by firms instead of consumers
  • Producers take most power in the relationship (in monopolies)
  • Doesn't account for equity
• how are resources allocated in a free economy?

  price mechanism
• The price mechanism is the way the basic economic problem is resolved in a market economy
• Signalling ( one function the price mechanism uses to allocate resources)

  • higher prices encourages new firms to enter the market
  • however also encourages consumers to reduce demand
• Incentive( one function the price mechanism uses to allocate resources)

  • encourages change in behaviour of consumers and producers
  • e.g higher prices = more profitable
• Rationing ( one function the price mechanism uses to allocate resources)

  • law of demand
  • prices will rise due to excess demand
  • = rations resources
  • discourages consumers to buy
• Allocating resources ( one function the price mechanism uses to allocate resources)

  • changing prices allocate scarce resources away from markets