Economies have to find a mechanism to allocate scarce resources because of the economic problem. The What, How, For Whom questions are central to the operation of this mechanism. To recap from the economic system lesson, the mechanism used by different systems: Command economy: Planning mechanism as dictated by the state Free Market economy: Price mechanism as dictated by consumer spending Mixed economy: A mixture of state planning and the market mechanism. Central to this module is an examination of the operation of the market economy, and how the price mechanism works to answer the what, how and for whom questions. Market: a mechanism which brings buyers and sellers together to trade if they are both happy. Different types of markets can exist, all operating along the same principles: Product: the market for goods, eg market for oranges Factor: the market for resource inputs, eg the labour market Capital: the market for finance, eg the market for bank loans
We will start off with examining the operation of a competitive market, where the buyers and sellers trade under equal conditions, and look how the price mechanism works to influence resource allocation.
The essential role of prices is to transmit information to different agents in the market place. Changes in price will result from changes in supply and demand conditions and will signal information about the state of the market which will influence the allocation of resources.
On the consumer side, changes in price perform a rationing function, transmitting information to them about whether they can afford to buy a product and how much they could buy at a particular price with a given amount of income. If the price of a product were to rise, consumers would be rationed out of the market, because their spending power would go down, ie they could not buy as much with a set amount of income. Conversely, if prices fell, consumers would berationed...