Agent Objectives

Specialist Terminology
Utility is a measure of relative satisfaction. In other words, it is a
term referring to the total satisfaction received by a consumer from
consuming a good or service. Given this measure, one may speak
meaningfully of increasing or decreasing utility.
Economic welfare: The level of prosperity and quality of living
standards in an economy. Economic can be measured through a
variety of factors such as GDP and other indicators which reflect
welfare of the population (such as literacy, number of doctors, levels
of pollution)
Scarcity, choice and the
allocation of resources
The Price Mechanism
What decides how resources are
allocated in a free market economy?
Agents incentive to MAXIMISE their objective
e.g. Labour will move to another company for a pay rise or better
perks. Firms will allocate capital resources to projects which
promise the highest profits. Consumers will buy the good/service
that best meets their needs and wants, others will cease to be
produced. Governments will use tax money to maximise welfare
and their chances of re-election.
Adam Smiths The invisible hand
The price mechanism
One of the Founding Fathers of economics
famously wrote of the invisible hand of the
price mechanism.
The price mechanism is a term used to
describe the means by which the many millions
of decisions taken each day by consumers and
businesses interact to determine the allocation
of scarce resources between competing uses.
This is the essence of economics!
The Role of Price and Profits in a Free Market Economy
Known as the MARKET MECHANISM
3 key functions:
Signalling function
Incentive function
Rationing function
The higher the price the more
attractive it is for entrepreneurs
to supply the good or service
(as it is more profitable to sell).
The price therefore provides an
INCENTIVE for suppliers to
supply the good or service.
The higher the price the less
consumers can buy, forcing
them to RATION their choices,
cutting back on the choices they
consider to be the poorest value
for money.
High prices indicate potential
profits for producers and send a
SIGNAL for firms to increase
output or for new firms to enter
the market to increase
availability
Real World Example of the 3 functions of
the Market Mechanism
Recent increase in oil prices, making petrol more
expensive for car owners
Car owners will then start to try and limit or ration the
amount of petrol they consume, cutting back on demand
Higher prices have now made harder to access oilfields
such as those in the Arctic Circle in northern Canada
viable business ventures for firms like BP and Shell,
which will increase supply
The high selling price may encourage entrepreneurs to
open new petrol forecourts
RATIONING
SIGNALING
INCENTIVE
Jan 11
5 mark define question
The price of apples rises. Explain the consequences of this given
the 3 key functions of price in a free market economy.
The price of chicken falls. Explain the consequences of this given
the 3 key functions of price in a free market economy.
Summary
Resources are allocated by the 3 functions of
the price mechanism. A change in price results
in a reallocation of resources due to the 3
functions of the price mechanism signalling,
incentive and rationing.
Role of incentives in decision making
The environment is a scarce resource which is
affected by economic decisions
Investigative Task
Identify a product thats price is rising in the
economy
Try to find a few reasons why this price is rising
Explain in your book how you would expect this
to impact on:
Consumers
Producers currently operating in the market
Retailers currently operating in the market
Entrepreneurs looking for ideas to make profit
Topical choices: petrol, food
Further Reading
Tutor 2 u sheet