Price and resource allocation

  • Prices provide the main method through which scarce resources are allocated between competing uses in economies


Types of market

Mixed economies

  • mix of private and state ownership of the means of production (capital) 
  • mix of market and non-market provision of goods and services - have a market and non-market sector 

Planned economies (command economies) - the planning mechanism allocates scarce resources among competing uses,  to provide goods and services such as police, roads and health care

Market economies - The price mechanism allocates scarce resources among competing uses in the markets that make up the economy  

The price mechanism operates within mixed and market economies, but only to a limited extent - e.g. the black market - in a planned economy 

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Three conditions that are necessary within and mar

  • The individual buyers and sellers decide what, how much, where and when to trade or exchange
  • They do so with reference to their self-interest and to the alternatives or opportunities open to them; the exchange must be voluntary; if one party forces a transaction upton the other, it is not a market transaction 
  • Prices convey information to buyers and sellers about self-interest and opportunities; for a market to allocate resources among different types of activity and to the coordinate economic activity throughout the economy, prices must repsond to the forces of supply and demand 
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Prices perform 3 main functions in a market or mix

The signalling function 

  • Prices signal what is available, convey the information that allows the traders in the market to plan and coordinate their economic activities
  • Markets will function inefficiently, sometimes breaking down completely - leading to market failure, if prices signal wrong or misleading information 

The incentive function 

  • Prices create incentives for economic agents (households and firms)
  • To behave and make decisions in ways consistent with purchasing and achieving the fulfilment of their self-interest

The allocative function or rationing function 

  • For markets to operate in an orderly and efficient manner, the buyers and sellers in the market must respond to the incentives provided by the price mechanism 
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