Introduction
When prices are above the market-clearing level, price floor increases the quantity supplied and decreases the quantity demanded, hence leading to surplus of goods. The price plays three important roles in allocation of resources in the market.
Signaling function\transmitting function
The basic role of price in the market is to convey information to variable agents in the market center. A market consists of buyers of commodities, and sellers of commodities. The relations of demand and supply fix the price at which trade occurs. A change in price will result in a change in supply and demand for commodities, which will gesture information regarding the state of the current market that influences resources allocation. Inadequate resources should attract higher prices, than plentiful resources (Montiel 2011).
Rationing function
The alterations in price has a rationing function on the consumers, relaying information to them on whether they can afford to buy a commodity, and they also asses how much they could buy the same product at a higher or lower price, with a certain income. For instance, if a product rose in price, the spending power of the consumer would decrease, and would ration them out of the market (Montiel 2011). In contrast, if the price of the same product fell, then purchasing power of the consumer would be high in relation to his income, and this rations the consumer into the market. The price’s rationing function is vital in the allocation of scarce resources.
Incentive function
The change in price plays an incentive role to both the buyer and the seller. For the producers, it is a signal of whether they should produce more or less of a commodity, while consumers decide if they purchase the same commodity twice as much or half their previous take. A rise in price motivates the producers to allocate more resources on goods production with a purpose of increasing their profits. Conversely, a reduction in price of a commodity would have a negative impact on the producers, discouraging production thus reducing the quantity of resources allocated to that particular good. This is because of reduced profit, which may drive some producers out of the market (Montiel 2011).
Conclusion
The role of price in resource allocation is vital to both the consumers and the producers, as it reflects on the current situation in the market. It also help consumers budget for their spending, while producers use price as a signal of the amount of commodity produce, and the size of resources they allocate for the production of commodities.
Montiel, P. J. (2011). Macroeconomics in Emerging Markets. New York: Cambridge University Press.
