Cambridge IGCSE Economics 0455
Syllabus points
- Describe the market system and how it allocates resources.
- Explain the three functions of price: signalling, incentive and rationing.
What is a market?
A market is any arrangement that brings buyers and sellers together to trade a good or service. It does not have to be a physical place — online shopping is a market too. In a market system, resources are allocated by the interaction of demand and supply through prices, rather than by government direction.
Key definitions
| Term | Definition |
|---|---|
| Market | An arrangement bringing buyers and sellers together to trade. |
| Price mechanism | The way changing prices allocate resources between markets. |
The three functions of price
Prices do three jobs that together decide *what, how and for whom* to produce:
- Signalling — a price change gives information. A rising price signals that a good is scarce or in high demand.
- Incentive — a higher price rewards producers, encouraging them to supply more (and consumers to buy less).
- Rationing — when a good is scarce, a higher price limits demand to those willing and able to pay.
Rising demand → higher price → signals scarcity → gives firms an incentive to supply more → rations demand → resources move into that market.
How the market answers the three questions
- What to produce? Goods that consumers demand and pay for.
- How to produce? Methods that keep costs low so firms can make a profit.
- For whom? Those able and willing to pay the market price.
Worked example
A new health trend raises demand for oats. The price rises (signalling greater demand), which gives farmers an incentive to grow more oats and switch land from other crops. Meanwhile the higher price rations oats to buyers most willing to pay. Resources have moved into oat production — all guided by price, with no government instruction.
Common exam mistakes
- Thinking a market must be a physical location.
- Listing only one function of price — learn all three.
- Confusing signalling and rationing.
Exam technique
Use the "signal → incentive → ration" chain to explain how any market reallocates resources after a change in demand or supply.
Quick revision
- Markets allocate resources through the price mechanism.
- Three price functions: signalling, incentive, rationing.