Price Mechanism
Price Mechanism
Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes
Price Mechanism
Prices are determined by the market forces of demand supply. Changes in demand / supply will cause an increase or decrease in the price of goods and services
Adam Smith proposed the theory ‘the invisible hand of the market’
Signal – changes in the price act as a ‘signal’ towards the allocation of scarce resources
The main functions of a Price Mechanism
Signaling Function
Prices adjust to highlight where resources need to be allocated. Producers will interpret the signaling function as a way of increasing or decreasing the quantity they supply. Prices rise to show ‘Scarcities’ and fall to show ‘surpluses’
Rationing Function
When there is a shortage of resources produced from excess demand and not enough supply, the prices increase so that only those which can afford them will be able to purchase.
Incentive Function
Consumers relay their change in demands / needs to producers through the choices they make. Producers use this information to adapt the goods / services they provide, as they are incentivised to make a profit
The Price Mechanism in different types of markets
Local Market
- An example of a Local Market is the Farm Market as the produce is grown and then sold to the local citizens.
- The buyers and sellers can only interact within the local area that they are restricted to
National Market
- The demand for goods is restricted to one specific country
Global Market
- The goods / services in one country can be bought and sold by people of other countries
- One of the largest markets consisting with people from several different countries – on a global scale
AQA Spec – Additional Content
Advantages of the Price Mechanism
Consumer Sovereignty
The Price Mechanism allows consumers to gain sovereignty as they may have power over what goods should be bought and sold
Invisible Hand acts as a signal
The Invisible Hand can signal the cost of purchasing a good to the consumer also what revenue producers will receive from selling the goods
Disadvantages of the Price Mechanism
Ignores Income Equality
The Price Mechanism and free market does not consider the distribution of income between people and disregards equality
Government Intervention
In the free market, it can be argued that government intervention is needed to correct market failure arising due to the under-provision of public and merit goods
Quick Fire Quiz – Knowledge Check
- Define ‘Price Mechanism’ (2 marks)
- Identify when a ‘scarcity’ of resources may occur (2 marks)
- Identify when a ‘surplus’ of resources may occur (2 marks)
- Identify and explain the three main functions of a Price Mechanism (6 marks)
- Explain the Price Mechanism in the context of a local market, national market, and a global market (6 marks)
Next Revision Topics
- Price Determination
- Market Equilibrium
- Demand
- Supply
- Scarcity
- Market Failure
- Asymmetric and Symmetric Information
A Level Economics Past Papers