the price mechanism

1. Price Mechanism
• Adam Smith spoke of the ‘invisible hand’ – through the
pursuit of individual self-interest, resources are allocated
in society’s best interests
• “The means by which the many millions of individual
decisions each day by consumers & firms interact to
determine the allocation of scarce resources.”

2. The Signalling Function
• Market prices adjust to ‘signal’ to producers where
resources are needed more and less
• Eg. if consumers want more iPods and less portable CD
players, prices for iPods will rise, signalling to producers
to allocate resources to their production

3. Incentive Function
• Prices provide incentive for consumers & producers to
use resources in the most efficient way
• Eg. high prices encourage efficiency; low prices
encourage utilisation of less valued resources

4. Rationing Function
• Resources are scarce
• Prices allocate resources to those willing to pay
• Eg. the more scarce a resource, the higher its price will be
and the less people will want / be able to have it