In six to ten sentences explain the role of price mechanism

In six to ten sentences explain the role of price mechanism in allocating resources in our economy. How is it different in a command economy? Provide examples as needed.

Solution

The price mechanism describes the means by which millions of decisions taken by consumers and businesses interact to determine the allocation of scarce resources between competing uses

The price mechanism plays three important functions in a market:

Transmission of preferences

Rationing function

Prices and incentives

Signalling function

If there is excess supply in the market the price mechanism will help to eliminate a surplus of a good by allowing the market price to fall.

Mixed and Command Economies and Prices

In a command economy, planning directs resources to where the state thinks there is greatest need. Following the collapse of communism in the late 1980s and early 1990s, the market-based economy is now the dominant system in most countries – even though we are increasingly aware of many imperfections in the operation of the market.