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A price signal is information conveyed to consumers and producers, via the price charged for a product or service, which provides a signal to increase supply and/or decrease demand for the priced item.
Pricing is a key issue 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.
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 the cost of production.
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 is not as direct as suggested in the theory of price signals, with other considerations playing a part.
Financial speculation – particularly buying or selling assets with borrowed money – can move prices away from their economic fundamentals. 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.
Firms use price discrimination to increase profits by charging different prices to different consumers or groups of consumers.