Price Mechanisms and Determination

How is resource allocation decided?

Free Market Economic System: the action of individual consumers, firms and households in the private sector which decide the allocation of resources. There is no government involvement so taxes or public spending.

Planned Economic System: the actions and decisions of the government/public sector which determines the allocation of resources.

Mixed Economy: the combination of public and private sectors which determine the allocation of resources.

The role of markets in allocating resources

Market - a set of arrangements that brings together all producers and consumers of a good or service so that they may engage in trade and exchange.

Market outcomes

• Market equilibrium is when at a given price, when quantity supplied is exactly equal to quantity demanded

• Market disequilibrium is when at a given price, when quantity supplied is not exactly equal to quantity demanded or consumed

How does the price mechanism work?

High or rising market prices provide private firms with important signals about what products consumers want and what amount they are willing to pay for it. This helps them identify what products are profitable to produce. In the same way, market price acts as a signal for firms to move their resources to the production of more profitable goods and services when the demand for the product falls.

It is defined as changes in market prices that provide the means by which decisions taken by private firms and consumers interact to determine how scarce resources are allocated between their competing uses.

At price P1, the quantity demanded is d, whereas the quantity supplied is s. At that given price(P1), the quantity supplied exceeds the quantity demanded resulting in excess supply or surplus. As a result, prices of that good or service could fall.

At price P2, the quantity demanded is d1, whereas the quantity supplied is s1. At that given price(P2),the quantity demanded exceeds the quantity supplied resulting in excess demand or shortage. As a result, the price of that good or service could rise.

At price P, the quantity supplied is exactly equal to the quantity demanded resulting in market equilibrium.