Price System of an Economy

The below mentioned article provides an overview on the Price System of an Economy. After reading this article you will learn about: 1. Subject Matter of the Price System 2. Limitations of the Price System 3. The Price System and Efficiency.

Subject Matter of the Price System:

Price theory operates in the price (or market) system or price mechanism. But what is the price system? The price system is a system of economic organization in which each individual in his capacity as a consumer, producer and resource owner is engaged in economic activity with a large measure of freedom.

In every society there are legal and social institutions. Individual economic actions must conform to them. In a free enterprise economy to which the price system primarily relates, the factors of production are privately owned.

The raw materials, the machines, factories and farms are owned by individuals who are at liberty to dispose of them in accordance with the prevalent laws of the country. It means that individuals have the right to acquire, dispose off, or lease property at will.

They have the freedom to enter into contracts, to borrow or lend at an agreed price. Individuals are free to choose any occupation, to buy and sell goods and services from anyone and to anyone based on mutual benefit. Thus the price system is a system of mutual exchanges and coordination which guides and organises economic activity efficiently, and leads to an efficient allocation of resources.

Limitations of the Price System:

The price system is not without limitations:

1. There is always an element of uncertainty when constant adjustments are taking place in the forces of demand and supply.

2. The process of adjustment is often painful and costly. Mistakes creep in. The economy is often engulfed in inflationary or deflationary processes. If, for instance, the supply of resources exceeds the demand for them, in the adjustment process both supply and demand will decrease. So the price system is costly and uncertain.

The Price System and Efficiency:

Every price system (or economy) seeks to attain efficiency with the limited resources at its disposal. In general, efficiency means the ability to make the best use of an economy’s available resources. Efficiency is of two types: technical and economic.

When an economy is producing the maximum output by making the fullest possible utilisation of its existing resources and technology, it is said to be technically efficient. The system is then producing on its production possibility curve. On the other hand, an economy achieves economic efficiency when it is producing the largest possible output of goods and services from its available resources.

When the system achieves economic efficiency, it also achieves technical efficiency and fulfils consumers’ preferences by producing those goods and services that people want with their available incomes. A deviation from this situation in the sense of a change in the combination of goods and services will lead to economic inefficiency. It will make someone better off while making someone else worse off.