Price Mechanism

Price Mechanism

Courses Info

Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes

Price Mechanism

Prices are determined by the market forces of demand supply. Changes in demand / supply will cause an increase or decrease in the price of goods and services

Adam Smith proposed the theory ‘the invisible hand of the market’

Signal – changes in the price act as a ‘signal’ towards the allocation of scarce resources

The main functions of a Price Mechanism

Signaling Function 

Prices adjust to highlight where resources need to be allocated. Producers will interpret the signaling function as a way of increasing or decreasing the quantity they supply. Prices rise to show ‘Scarcities’ and fall to show ‘surpluses’

Rationing Function

When there is a shortage of resources produced from excess demand and not enough supply, the prices increase so that only those which can afford them will be able to purchase.

Incentive Function

Consumers relay their change in demands / needs to producers through the choices they make. Producers use this information to adapt the goods / services they provide, as they are incentivised to make a profit

The Price Mechanism in different types of markets

Local Market

  • An example of a Local Market is the Farm Market as the produce is grown and then sold to the local citizens.
  • The buyers and sellers can only interact within the local area that they are restricted to

National Market

  • The demand for goods is restricted to one specific country

Global Market

  • The goods / services in one country can be bought and sold by people of other countries
  • One of the largest markets consisting with people from several different countries – on a global scale

AQA Spec – Additional Content

Advantages of the Price Mechanism

Consumer Sovereignty

The Price Mechanism allows consumers to gain sovereignty as they may have power over what goods should be bought and sold

Invisible Hand acts as a signal

The Invisible Hand can signal the cost of purchasing a good to the consumer also what revenue producers will receive from selling the goods

Disadvantages of the Price Mechanism

Ignores Income Equality

The Price Mechanism and free market does not consider the distribution of income between people and disregards equality

Government Intervention

In the free market, it can be argued that government intervention is needed to correct market failure arising due to the under-provision of public and merit goods


Quick Fire Quiz – Knowledge Check

  1. Define ‘Price Mechanism’ (2 marks)
  2. Identify when a ‘scarcity’ of resources may occur (2 marks)
  3. Identify when a ‘surplus’ of resources may occur (2 marks)
  4. Identify and explain the three main functions of a Price Mechanism (6 marks)
  5. Explain the Price Mechanism in the context of a local market, national market, and a global market (6 marks)


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