Price signal

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A price signal is information conveyed, to consumers and producers, via the price charged for a product or service, thus providing a signal to increase supply and/or decrease demand for the priced item. [1]

Price systems[edit]

Free price system[edit]

Main article: Free price system

For example, in a free price system, rising prices may indicate a decrease of supply or an increase in demand. Regardless of the underlying reason—and without the consumer needing to know the cause—the price increase communicates the notion that consumer demand (at this new, higher price) should recede or that supplies should increase. Consumers that do continue to purchase the product at the higher price ostensibly give the product a higher marginal utility. This results in a natural market correction, according to the Austrian theory of catallactics.

Fixed price system[edit]

Main article: Fixed price system

In a fixed price system where prices are set by government, price signals may not be as reliable as indicators of shortages, surpluses, or consumer preferences according to opponents of planned economies. These artificial prices may create shortages and surpluses that would not occur under a free price system.

An alternative theory of centrally planned economies, the shortage economy theory of Hungarian economist János Kornai argues that it is not a failure of the pricing mechanism, but rather a systemic failure to produce enough goods, since shortages were obvious but persisted.

Alternative theories[edit]

For more details on this topic, see Outline of industrial organization.

How prices are set is a key question in the theory of industrial organization. The theory of price signals argues that higher prices reflect either increased consumer demand (thus spurring higher production), or increased producer costs (thus reducing consumption), allowing the coordination of the economy. For example, if a producer charges a fixed percentage markup, then prices reflect costs of production, and changes in price correspond to changes in production, rather than changes in profit.

Pricing power[edit]

Alternative theories include that prices reflect relative pricing power of producers and consumers – for example, a monopoly may set prices so as to maximize monopoly profit, regardless of actual costs of supply or demand, while a cartel may engage in price fixing. Conversely, on the consumer side, a monopsony may negotiate or demand prices that do not reflect actual demand or cost of production.

Value[edit]

A long thread in economics (from Aristotle through classical economics into the present) distinguishes between exchange value, use value, price, and (sometimes) intrinsic value. It is frequently argued that the connection between price and other types of value are not as direct as suggested in the theory of price signals, with other considerations playing a part.

Notably, in Marxian economics, the setting of prices is analyzed in the Law of value, which argues among other points that prices charged and wages paid do not reflect the labor value involved in production.

Speculation[edit]

It is also argued that financial speculation – particularly buying or selling assets with borrowed money – can result in prices varying significantly from their economic fundamentals; it is generally accepted that credit bubbles can sometimes distort the price signal mechanism, causing large-scale malinvestment and financial crises. Adherents of the heterodox economic school known as Austrian economics attribute this phenomenon to the interference of central bankers, which they propose to eliminate by introducing full-reserve banking, while the post-Keynsian economists such as Hyman Minsky have described it as a fundamental flaw of capitalism, to be corrected by financial regulation. Both of these schools have been the subject of renewed attention in the Western world since the financial crisis of 2007–2010.

References[edit]

  1. ^ Boudreaux, Donald J. "Information and Prices". The Concise Encyclopedia of Economics. Library of Economics and Liberty (econlib.org). Retrieved 11 January 2013.