Price Mechanism

​The price mechanism plays 3 important roles in allocating resources in a market:

1. Signalling – they adjust to show where resources are or are not required. Prices rise and fall to show surpluses or scarcities. If prices are rising because of high demand, it signals producers to expand supply. An example would be the price of a local newspaper increasing due to high demand signaling to the printer to produce more of the paper to meet demand.
2. Rationing – When there is a shortage of goods or services, the price rises. This leaves only those willing and able to purchase the good in the market (i.e. those who gain most utility from the product). The effect is rationing demand with supply.
3. Incentive – Higher prices provide an incentive to existing producers to supply more as they are able to produce larger profits.

 
Resources are allocated this way in a free market economy as prices solely dictate the allocation of resources.

Advantages of the Price Mechanism	Disadvantages of the Price Mechanism
Resources are allocated as per consumers' wants and needs.	Public goods are not produced.
It operates without the need of employing labour.	Unemployment among the lower-skilled workers is likely to be higher, and also lower wages among this group.
Prices are kept at an efficient, minimal level as resources are used at maximum efficiency.	Inequality in wealth and income is usually a byproduct.
Consumers decide what is produced.	Under-provision of merit goods, over-provision of demerit goods.