We know that the interaction of supply and demand in a market system creates prices for the goods and services exchanged. Prices perform two major roles in market systems: 1) rationing the available goods and services, and 2) determining which goods and services are produced and how they're produced. Let us look at each of these in more detail.

Price rationing

First, prices perform a means of rationing scarce goods and services. This price rationing function answers the third basic question that economic systems must address: who gets the goods and services that are produced?

Remember, goods are not freely available (there is no free lunch). For a good to be freely available, there must be enough to go around freely to everyone who wants it. While this may be true for a handful of goods, virtually all of the millions of goods and services exchanged in any economic system are not freely available. Because there is not enough to go around freely, not everyone who wants a good will be able to get it. Such goods must be rationed, which means there must be some mechanism for deciding who gets some of the goods and who does not.

In market systems, such rationing is done by price. You can have a particular good if you are willing and able to pay the market price. If not, you look for some alternative. Consider the following figure that shows the effects of closing some of the lobster waters off the coast of Maine in order to reduce over-harvesting.

Since some of the lobster waters are closed, fewer lobsters will be harvested. A shifting of the supply curve to the left indicates this decrease in supply. There are fewer lobsters to go around, which means some people that used to eat lobsters will not be eating any, or at least not eating as many as they were before. Who decides which people will be cutting back and by how much? We do! As a result of the decrease in supply, there is an increase in price. Fewer people will be willing and able to pay the new, higher price for lobster. It is the price itself that rations the available lobsters.