Price Mechanism

Price Mechanism

Price Mechanism, a device for limiting to particular uses the use of resources and the consumption of goods with alternative applications. It is thus a means of guiding, controlling and 'rationing' production and consumption.

Prices are the money values of goods and services. In particular cases and at a particular time they may be determined by custom, by an arbitrary authority, by higgling in separate transactions, by a privileged monopolist or by competition in a free market. But in general the price mechanism under a system of broadly free competition serves as a coordinating device for goods produced for sale in markets to consumers who buy with the money they have received from payments for their own productive activity.

The price mechanism is a characteristic of the complex modern economy; it operates in different forms and to differing extents in various countries. In earlier societies it did not exist. The adoption of the price mechanism as the co-ordinating force in economic development indicates, historicaily, its superiority over other possible mechanisms, such as political authority, to carry out a deliberately conceived policy. This superiority rests on two considerations. First, the employment of money as a conventional unit of reckoning values eases comparison and makes choice between goods more informed and accurate. The use of prices as guides to the selection of occupations, the purchase of goods and generally in the organization of economic activities has tended thus to sharpen economic judgment and to make choice more fruitful. Secondly, the price mechanism provides a convenient means of enforcing checks on the use of resources which are inescapable but which are more accepted in so far as they appear to be the work of fate. The application of scarce means to specific ends unavoidably excludes their use for others; the necessary frustrations and deprivations of the economic process inevitably appear less onerous when they are not enforced by the arbitrary will of human authority.

The criticisms levied against the price mechanism normally derive from practical disillusionment rather than from theoretical inquiry. When working men found that the price mechanism in a free market worked unfavourably to their interests they determined to bargain collectively and to sell their labour not at free market prices but at 'fair' prices. Business men saw that free market prices for their goods were not always profitable, and patents and other forms of restriction openly became more widespread. Consumers became aware that prices were no longer the outcome of a multitude of spontaneous forces represented by the bids and offers of innumerable individuals in pursuit of private interests. The result was that in various directions practical expediency brought about a considerable departure from the rules of market conduct prescribed by the price mechanism. Resources were not allowed to flow without help or hindrance where prices dictated; they were diverted (e.g. by subsidies, tariffs and trusts); methods of production were no longer based solely on cost-price considerations; there were others (e.g. factory legislation, health regulations); the distribution of income by the processes of the market was interfered with (by collective bargaining, rate regulation, etc.). In these and other ways the working of the price mechanism has in the twentieth century been amended, restricted and in some cases destroyed at least for a time. On the other hand recent developments in the communist countries, Russia, Yugoslavia, Poland, Hungary and others, suggest that prices and markets cannot be suppressed easily, generally or permanently, but tend to form spontaneously where individuals or groups find they can benefit from exchange of goods or services.

Prima Fade, 'at first sight', Latin term frequently used by economists in discussing the apparent rather than the real causes or consequences in an analytical or applied problem.

Private Enterprise, the economic activities of a community which are independent of Government control and directed to satisfy private wants. In spite of the recent growth of public ownership, productive activity in most western countries is still predominantly in the hands of private enterprise, based on the institution of private property, the principal distinguishing feature of a capitalist society. The essence of private enterprise is freedom of economic activity: subject to certain restrictions, people are free to use their property, income and skills in the ways they please.

In attempting to produce efficiently and avoid waste, every society faces the same economic problems: the quantity and type of goods it should produce, the best techniques and locations for production, the appropriate channels of distribution, etc. The significant feature of a private enterprise system is that individuals acting independently and without Government control or direction manage to solve the problems more or less to their satisfaction. The overriding desire of business men is to make their enterprises as profitable as possible. In general, it is profitable to produce only what people are prepared to pay for, and if markets are competitive the interests of the manufacturers and the community tend to coincide. Every penny a consumer spends on a commodity is in a sense a 'vote' in favour of its continued production. The changing flow of consumers' expenditure provides a continuous 'referendum' as a guide to production. Rising prices and profits, usually a sign of strong demand for a commodity, act as a stimulus to production; and falling prices and losses, which indicate that resources could be better employed elsewhere, tend to discourage production. Since it also pays to produce as efficiently as possible, the aim of higher profits tends to lead to an economic use of resources.

The private enterprise system in practice is often far from perfect. The interests of the public and of private business are not always identical. The working of the system may be marred by the activity of groups trying to obtain for themselves (at the expense of the rest of the community) positions of greater advantage than could be enjoyed under free competition. The sluggishness of some prices, or of responses to price changes, may lead to long periods of maladjustment. To promote and sustain smoother working of the system a framework of law and institutions is necessary. Some economists suggest that these problems can be solved only by abandoning private enterprise and substituting a Government controlled economy. Others contend that private enterprise offers considerable advantages, such as a flexible system of meeting the community's needs without elaborate administrative machinery or restriction of individual freedom.

Further reading Economic - Experimental Economics


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