Why does the Price Mechanism exist and what are the functions of it?

In Economics we study the idea of 'scarcity' (also known as the Economic Problem). Scarcity means that there is a finite amount of resources and an infinite amount of wishes. The Price Mechanism exists to allocate the scarce resources amongst the competing uses. 

There are three functions of the Price Mechanism. Firstly, it acts as a signalling function, demonstrating when there are surpluses and scarcities through price increases and decreases. Secondly, it acts to transmit the preferences of the consumer to the producers, as it shows where the demand is. Thirdly, it acts as a rationing function, meaning that if there is a shortage of the resource or product supply contracts causing the price to increase, leading the demand to equate to the supply once again.

BA
Answered by Becky A. Economics tutor

2485 Views

See similar Economics A Level tutors

Related Economics A Level answers

All answers ▸

What impact would a cut in the base rate by the Bank of England have on Aggregate Demand?


Explain the impact of incentives on the behaviour of economic agents and resource allocation.


Do subsidies to producers always correct market failure? As an essay style question.


If mpc = 0.6, what will be the final change in National Income arising from an initial increase in Investment of £200m?


We're here to help

contact us iconContact ustelephone icon+44 (0) 203 773 6020
Facebook logoInstagram logoLinkedIn logo

MyTutor is part of the IXL family of brands:

© 2025 by IXL Learning