9 Major Limitations of the Price Mechanism

The following points highlight the nine major limitations of the price mechanism.

Some of the limitations are: 1. Perfect Market is an Unreal Market 2. Sellers Influence Prices in the Real World 3. Price Adjustment is not Automatic 4. Consumer’s Sovereignty is Unreal 5. Competition Leads to Monopoly 6. Wastage of Resources May Occur and Others.

Price Mechanism: Limitation # 1. Perfect Market is an Unreal Market:

For its efficient functioning, price mechanism crucially depends on the characteristics of product market and factor market. To be more specific, these two markets must be characterized by perfect competition. But such perfect competition did not exist, nor any modern economy is characterized by perfect competition, or ever will it be.

In reality, no one finds free entry, perfect mobility of inputs, etc. Under this situation, price system cannot operate efficiently. If so, price mechanism fails to answer fundamental economic problems.

Price Mechanism: Limitation # 2. Sellers Influence Prices in the Real World:

Prices are not necessarily the result of interaction of impersonal forces of demand and supply because real markets are far away from ideal pure competitive markets.

Real market is usually characterized by monopoly or oligopoly. A monopoly seller has the power to influence price of his product as well as output. This is true also for oligopoly sellers. These sellers charge high prices for their products by restricting output.

Price Mechanism: Limitation # 3. Price Adjustment is not Automatic:

It is argued that, under price mechanism, supply of commodities responds to changes in demand conditions in such a way that supply-demand equality is automatically restored. However, this is not true because firms may plan to raise output when demand rises.

Producers, being profit-maximisers, may not increase output. They anticipate that buyers would buy product at higher prices and so their profits would be higher. As a result, demand-supply adjustment may take place after a long interval.

Price Mechanism: Limitation # 4. Consumer’s Sovereignty is Unreal:

The sovereignty of consumers is unreal since consumers buy the commodities producers produce in accordance with their wishes. Consumers are forced to purchase those goods which producers want. Thus, the producer is the sovereign, not the consumer. Consumers are merely puppets. Consumers’ choices may be distorted by advertising too.

Price Mechanism: Limitation # 5. Competition Leads to Monopoly:

Competition, in the long run paves the way for the emergence of monopoly business where resources are never optimally utilized and consumers do not get the right thing at the right price.

Price Mechanism: Limitation # 6. Wastage of Resources May Occur:

Wastage of resources even under price system is unavoidable. In fact, competition and, hence, rivalry, in the long run raises inefficiency and makes production expensive. For sheer survival, producers often make advertising expenditures so as to attract more customers. Such a strategy is a costly one. This means resources are wasted. Competition is good; but cut-throat competition can never bring welfare to the society.

Price Mechanism: Limitation # 7. Causes Instability:

A free, unregulated price system is bound to produce instability in the economy. This means that booms and recessions appear and disappear. The rate of growth, investment, price level, employment etc., fluctuates in an alternating way. Such fluctuations in the levels of economic activities create a variety of socio-economic problems.

Price Mechanism: Limitation # 8. Creates Inequality:

The price system breeds inequality in the distribution of income and wealth. We have seen that consumers ‘vote’ for buying goods and services. In a market economy, a vote is cast not by ballot but by money power. Thus, money votes are important. People with high income have more voting power than the poor.

Producers produce goods and services for them who have large money power. Thus, the price mechanism cannot ensure social justice; rather, it widens inequality in the distribution of income and wealth—‘the rich get richer, the poor poorer’.

Price Mechanism: Limitation # 9. Market Fails:

Finally, market or price mechanism fails to achieve social efficiency. Economists call this ‘market failure’. Market failure means that prices fail to provide proper signals to economic agents. It is a phenomenon in which the market solution (i.e., free play of market forces) does not lead to a social optimum.