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Wednesday, 24 August 2011

Word of the Day

Functions of price

1. The signalling function

Prices give information to consumers to help them decide what they should buy. A simple example would be to take the example of cameras. If a disposable camera is more expensive than a digital camera, then this conveys information to the consumer that a digital camera may have more functions, take better pictures, be easier to use…etc.

2. The rationing function

Prices can allocate resources accordingly given that consumers have a fixed income. It rations and allocates scarce resources among competing uses. For example, if my income was fixed at £20,000 per annum, I may choose not to buy a £150 handbag because my income may not support such a purchase. However if my income was £170,000 per annum, I might choose to purchase the handbag because I can afford to given my income levels.

3. The incentive function

Prices create incentives for consumers to alter their economic behaviour. For example, if a retailer cuts the price of bread by 50%, consumers are given incentives to buy a loaf of bread. This is because a loaf of bread is cheaper relative to other goods that the same amount of money can buy.