Price mechanism refers to the system where the forces of demand and supply determine

the prices of commodities and the changes therein. It is the buyers and sellers who actually
determine the price of a commodity.

The problem of scarcity forces societies to make choices. These choices affect the
decision of what to produce, which is one aspect of resource allocation. However,
resource allocation also involves deciding which resources to use and in what
quantities to produce the chosen combination of goods and services, i.e. how to
produce the goods and services societies choose.
In a free market economy, as a result of the interaction of the forces of
demand and supply, the price mechanism determines resource allocation in an
economy
Forces of demand and supply move markets to an equilibrium. When market
forces dictate that a certain amount of a good or service is to be produced and
consumed, it requires a certain amount and combination of resources to be allocated
to the production of these goods.
Resources are allocated and reallocated in response to price changes. prices
function as signals and incentives to consumers and producers in making their
economic decisions
If there is an increase in the price of a good as a result of an increase in demand,
for example, this gives a signal to producers that consumers want to buy this good.
As producers are profit driven (i.e. they seek to maximise their profits), they will be
motivated to produce those goods that can bring them a higher profit. Higher prices
then function as an incentive for producers when deciding what to produce.
As signals, prices communicate information to decision makers. The relative prices of
factors of production also serve as signals and incentives in the decision of how to
produce. Again, as producers are profit seekers, they will tend to produce those
goods which are more demanded by consumers, but they will try to produce them at
the lowest possible cost. This means that the combination of resources used to
produce the goods will also depend on the prices of factors of production
For example, in Argentina beef would be produced using more of the factor
'land', which is abundant and therefore cheaper than in Japan, where 'land' is relatively
more scarce and expensive. In Japan producers of beef would allocate less of the
resource 'land' to the production of beef than Argentine producers.
Another example is the production of goods in China, which allocates more of the
factor of production 'labour' than the factor 'capital' because it is relatively cheaper. As
China has abundant factors of production 'labour', Chinese producers of clothes
allocate more of this resource to the production of jeans than Germany where the price
of 'labour' is higher; consequently, German producers allocate a higher proportion of
'capital' and less 'labour' to their production processes