The price mechanism: prices, set by demand and supply, decide what is produced, how much, and for whom.
Three jobs of a price
Signal
A rising price tells everyone the good is wanted more or is scarcer.
Incentive
A higher price means more profit, so firms make more and new firms join.
Ration
A higher price means buyers who value it less stop buying, so the scarce goods go to those willing to pay.
The points to remember
- Write it like this: "Signalling and the incentive function move resources towards goods whose prices rise."
- "Rationing: a higher price shares out a scarce good among the buyers willing to pay."
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More people want oat milk. Watch what the price does, and who reacts.
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Resources move between markets
Oat milk price up
Oat farms earn more, so they plant more oats.
Cow's milk price down
Fewer buyers, so dairy farms earn less.
Land, labour and capital move
From dairy to oats, with no one in charge.
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Paper 1 part (a), 10 marks.
Explain how the price mechanism allocates resources in a free market.
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How the 10 marks are given
| Marks | What your answer needs |
|---|---|
| 9–10 | Theory fully explained, terms used correctly all the way through, the diagram included and fully explained |
| 7–8 | Theory explained, terms mostly right, the diagram included and explained |
| 5–6 | Theory partly explained, some terms, the diagram included |
| 1–4 | Theory only described or stated; few relevant terms |