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What is the rationing function and the guiding function of price?

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Suppose that the demand for pizza increases. Carefully explain how the rationing function of price will restore market equilibrium. Explain the long-run effects of the guiding function of price in this scenario.

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Solution Summary

The inequilibrium in the market, either a shortage of a surplus, will cause an adjustment in the market through price mechanism. In the short run the rationing function will lead to the short-run equilibrium price and quantity. However, in the long run resources will be reallocated in the economy through the guiding function of price and a new equilibrium will be established. This solution discusses these concepts in depth.

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See the attached file.

Note: refer to the attached graph for clarification.

The increase in demand implies a shift in demand curve for pizza to the right, from D1 to D2. The change in demand is due to factors that we called demand shifters. They are income, taste and preference, price of related goods, and population.

Immediately after the increase in demand causes a shortage at the original equilibrium price (P1); the quantity supplied is less than the new ...

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