In this essay, I would like to analyze the kinds of information market prices convey and why this information is important for the efficient allocation of scarce resources.

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In the modern world, the world economy is a mixed economy of which free-market economy is the greater part. The price system is a fundamental and significant mechanism of it. It is the price system that enables people living all over the world to cooperate while each one goes after his own interests. That is because everyone goes about his own business with the information he gets, and in standard models, information is only transmitted through market prices. So it is very clear that, in current economy, market prices have a very particular informational role. In this essay, I would like to analyze the kinds of information market prices convey and why this information is important for the efficient allocation of scarce resources.

First, let me take a true thing for example. In 2001, the conference of APEC was taken place in Shanghai. Besides the contents of the conference, it was very interested in by the reporters that all the government leaders from different countries who attended the conference wore the clothes in the style of Tang Dynasty. After the conference, in became a fashion to wear the clothes of this style in China, even all over the world. That means there was a great increase in the demand of these clothes. Then, the clothes shops would need more these clothes to sell, so they would order more from the clothes factories. To satisfy the demand of the clothes, the factories had to producers more these clothes which were made of silk, so they would order more silk from the firms who can supply them with enough silk. The firms would have to offer higher prices to buy more silk from the farmers who raised silkworms and it would cost them more to process the silk. Besides more money the clothes factories had to pay for the silk, they also have to offer higher wages and better working condition to hire more worker producing these clothes. This means the cost of the production increased, and the price at which they sold the clothes to the shop would also rise. As a result, consumers would buy these clothes at a much higher price. What we can see from this example is that the information that the demand of these clothes increased is transmitted through the rise of the price between different individuals.

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Demand is the total quantity of a good or service wanted at a given price over a period of time (lecture note). From the demand curve we can see that there is an inverse relationship between the price of a product and the amount of demand for this product. The higher the price, the lower the demand and the lower the price, the higher the demand while others things unchanging. This is called “the general role of demand”, which can be explained further by the income effect and the substitution effect (lecture note). The income effect refers to that ...

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