Role Of Price Mechanism In Econmic Syst
The role of price mechanism in a free market economy or capitalism!
The price system functions through prices of both goods and services. Prices determine the production of innumerable goods and services.
They organise production and help in the distribution of goods and services, ration out the supplies of goods and services and provide for economic growth. Let us analyse the role of prices in all these spheres.
(1) What and How Much to Produce:
The first function of prices is to resolve the problem of what to produce and in what quantities. This involves allocation of scarce resources in relation to the composition “of total output in the economy. Since resources are scarce, the society has to decide about the goods to be produced: wheat, cloth, roads, television, power, buildings, and so on. Once the nature of goods to be produced is decided, then their quantities are to be decided.
How many kilos of wheat, how many million metres of cloth, how many kilometers of roads, now many televisions, how many million kw of power, how many buildings, etc. Since the resources of the economy are scare, the problem of the nature of goods and their quantities has to be decided on the basis of priorities or preferences of the society. If the society gives priority to the production of more consumer goods now, it will have less in the future. A higher priority on capital goods implies less consumer goods now and more in the future.
This problem can be explained with the help of the production possibility curve, as shown in Figure 7.1. Suppose the economy produces capital goods and consumer goods. In deciding the total output of the economy, the society has to choose that combination of capital and consumer goods which is in keeping with its resources.
It cannot choose the combination R which is inside the production possibility curve PP, because it reflects economic inefficiency of the system in the form of unemployment of resources. Nor can it choose the combination K which
The price system functions through prices of both goods and services. Prices determine the production of innumerable goods and services.
They organise production and help in the distribution of goods and services, ration out the supplies of goods and services and provide for economic growth. Let us analyse the role of prices in all these spheres.
(1) What and How Much to Produce:
The first function of prices is to resolve the problem of what to produce and in what quantities. This involves allocation of scarce resources in relation to the composition “of total output in the economy. Since resources are scarce, the society has to decide about the goods to be produced: wheat, cloth, roads, television, power, buildings, and so on. Once the nature of goods to be produced is decided, then their quantities are to be decided.
How many kilos of wheat, how many million metres of cloth, how many kilometers of roads, now many televisions, how many million kw of power, how many buildings, etc. Since the resources of the economy are scare, the problem of the nature of goods and their quantities has to be decided on the basis of priorities or preferences of the society. If the society gives priority to the production of more consumer goods now, it will have less in the future. A higher priority on capital goods implies less consumer goods now and more in the future.
This problem can be explained with the help of the production possibility curve, as shown in Figure 7.1. Suppose the economy produces capital goods and consumer goods. In deciding the total output of the economy, the society has to choose that combination of capital and consumer goods which is in keeping with its resources.
It cannot choose the combination R which is inside the production possibility curve PP, because it reflects economic inefficiency of the system in the form of unemployment of resources. Nor can it choose the combination K which