As prices rise, excess demand is removed and only those consumers with the ability to pay are able to purchase the good. Increasing prices rations demand to those most able to afford the good or service.
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How does the signalling function work?
Prices provide important market signals to market participants.
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How does the incentive function work?
Increased prices strengthen incentives to firms to produce more in order to make profit.
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How does the allocative function work?
It acts to divert resources to where they can maximise their returns and away from uses where they do not.
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What is said to occur if any of the functions break down?
Market failure.
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Other cards in this set
Card 2
Front
How does the rationing function work?
Back
As prices rise, excess demand is removed and only those consumers with the ability to pay are able to purchase the good. Increasing prices rations demand to those most able to afford the good or service.
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