How markets allocate resources through the price mechanism, the rationing, signalling and incentive functions of price, and the primary, secondary and tertiary sectors of the economy.

What this dot point is asking

AQA wants you to explain how markets allocate scarce resources through the price mechanism, describe the rationing, signalling and incentive functions of price, and identify the primary, secondary and tertiary sectors. This is the link between the economic problem (scarcity and choice) and the demand-and-supply diagrams you use throughout Paper 1.

How markets allocate resources

When demand for a good rises, its price rises, which draws resources towards that good; when demand falls, the price falls and resources move away. In this way prices coordinate the decisions of millions of consumers and producers automatically.

The three functions of price

• Signalling: a price acts as a signal that carries information. A rising price signals that a good is wanted more (or has become scarcer); a falling price signals the opposite. Producers and consumers read these signals and adjust.
• Incentive: prices give people a reason to act. A higher price gives firms an incentive to supply more (it is more profitable) and gives consumers an incentive to buy less and look for substitutes.
• Rationing: when a good is scarce, its price rises, which rations the limited supply to those most willing and able to pay. The market clears without queues or rationing books.

A poor wheat harvest shows all three at once: scarcity pushes the price up (rationing), the high price signals a shortage, and it gives farmers an incentive to plant more wheat next season.

The economic sectors

As a country develops, the balance between sectors changes. Early on, most output and jobs are in the primary sector. As the country industrialises, the secondary sector grows. In a mature economy like the UK, the tertiary (service) sector dominates output and employment, while the primary sector becomes a small share.

Why the sectors matter

A shift between sectors changes the kinds of jobs and skills an economy needs. The decline of a sector (for example coal mining) can cause structural unemployment if workers' skills no longer match the jobs available, which links to government policy and the labour market.

Worked example

Try this

Q1. Name the three functions of the price mechanism. [2 marks]

• Cue. Signalling, incentive and rationing.

Q2. Explain how a rise in price rations a scarce good. [3 marks]

• Cue. A higher price means only those most willing and able to pay still buy the good, so the limited supply is shared out by ability and willingness to pay rather than by queues.