1.2.7 Price mechanism

• Price mechanism:


  How resources are allocated in a market economy through the forces of demand and supply.

  Three functions: a rationing function, a signalling function, and an incentive function.
• Rationing' function of the price mechanism

  Prices act as a rationing mechanism to allocate scarce resources among competing uses.

  When D>S, prices ↑ , discouraging some consumers from buying, and ensuring that goods are allocated to those willing to pay the highest prices.
• Signalling' function of the price mechanism

  Prices convey information about changing market conditions, allowing consumers and producers to make informed decisions.

  Rising prices may signal potential shortages, prompting consumers to conserve and producers to increase supply.

  Falling prices may indicate oversupply, prompting consumers to buy more and producers to cut back on production.
• Incentive' function of the price mechanism

  Prices provide incentives for producers to allocate resources efficiently.

  Higher prices indicate increased demand, motivating producers to produce more of a particular good or service.

  Lower prices signal decreased demand, encouraging producers to reallocate resources to more profitable uses.