The Price Mechanism
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The price mechanism In solving the 3 basic problems of an economy
Meaning • A system where price acts as automatic signals which coordinate the actions of individual decision making units • Applicable in capitalist economies
Types • Price mechanism under free market economy • Price mechanism under controlled or command economy
Difference • Adjustment in prices • through demand supply interaction • Relevant for capitalist • economy • Solves economic • problems through market forces
Administered price mechanism to achieve pre specified economic targets Relevant for socialistic economy Solves economic problems through planning with positive government intervention
FUNCTIONS OF PRICE MECHANISM • • • • • • •
The level of economic activities Co-ordination of economic decisions Guiding force to consumers and producers Determination of factor income Allocation of resources Determination of savings Flexibility of the economy
Solutions to the basic problems What to produce?
1. Commodities with positive prices 2. More of Commodities with relatively higher prices
How to produce?
1. Production technique chosen according to factor prices 2. Employing factors which are relatively abundant and also cheaper
For whom to 1. Depends on purchasing power produce? 2. Factor income
Conditions for free price mechanism • • • • • •
Output exceeds self consumption Technology developed enough Facilities of exchange Existence of competition Mobility of resources Demand reflecting need and cost reflecting sacrifice • Non economic conditions
Evaluation: advantages • • • •
No intervention: self enforcing Preservation of individual freedom Promotes social welfare Solves economic problems
Evaluation: limitations • • • • •
Creation of monopoly Inequality in the standard of living Problem of economic development Problem of business cycle Production of public utilities neglected
Role of government • Prices are administered • Decisions of production , consumption and distribution are controlled • Allocation of factors and their income decisions are controlled • Direct and indirect role of government in solving economic problems
Which mechanism is suitable for a mixed economy
?
Meaning • A system where price acts as automatic signals which coordinate the actions of individual decision making units • Applicable in capitalist economies
Types • Price mechanism under free market economy • Price mechanism under controlled or command economy
Difference • Adjustment in prices • through demand supply interaction • Relevant for capitalist • economy • Solves economic • problems through market forces
Administered price mechanism to achieve pre specified economic targets Relevant for socialistic economy Solves economic problems through planning with positive government intervention
FUNCTIONS OF PRICE MECHANISM • • • • • • •
The level of economic activities Co-ordination of economic decisions Guiding force to consumers and producers Determination of factor income Allocation of resources Determination of savings Flexibility of the economy
Solutions to the basic problems What to produce?
1. Commodities with positive prices 2. More of Commodities with relatively higher prices
How to produce?
1. Production technique chosen according to factor prices 2. Employing factors which are relatively abundant and also cheaper
For whom to 1. Depends on purchasing power produce? 2. Factor income
Conditions for free price mechanism • • • • • •
Output exceeds self consumption Technology developed enough Facilities of exchange Existence of competition Mobility of resources Demand reflecting need and cost reflecting sacrifice • Non economic conditions
Evaluation: advantages • • • •
No intervention: self enforcing Preservation of individual freedom Promotes social welfare Solves economic problems
Evaluation: limitations • • • • •
Creation of monopoly Inequality in the standard of living Problem of economic development Problem of business cycle Production of public utilities neglected
Role of government • Prices are administered • Decisions of production , consumption and distribution are controlled • Allocation of factors and their income decisions are controlled • Direct and indirect role of government in solving economic problems
Which mechanism is suitable for a mixed economy
?
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