Answer to Question #306229 in Microeconomics for Khan

Question

Describe the role of prices in market economies.

Answer 1

Prices play a vital role in the market economy. Some of the major roles of prices include:

a) It acts as a signaling function. It signalizes the demand and supply situations where shortages are reflected in high prices of commodities and surpluses reflected by lower prices of goods.

b) It shows the rationing function by determining limited vs. unlimited resources. The limited resources are high in price while the unlimited resources have low prices.

c) It is used as an allocative function by indicating what, when, and whom to produce in terms of products and services.

d) Prices facilitates matching of demand and supply to reach at a neutral level, which makes price to have an equilibrium function.

e) Prices acts as incentives where high prices acts as disincentives to consumers and low prices are incentives to them.

f) Prices enhances marketing efficiency and performance. Wrong prices hinder smooth functioning of the market resulting in poor performance.