Market Price convey information

Prices play a key role in the market economy. The central problem of economic is to allocate scarce resources efficiently. Prices as a vehicle convey sufficient information to all traders in the market for their economic activities and ensure that goods will be allocated efficiently. There are a lot of transactions between buyers and sellers in the market, individuals pursuing their own self-interest and aim to maximize utility; companies provide goods and services by the aim to make profits, each seeking their own interest. Price mechanism coordinate these transactions and in such a way to make everyone better-off. Market price serves as an “invisible hand” guiding resources to their most efficient uses.

First, for the further argumentation, I will explain how prices convey information, namely how price mechanism works. Suppose that, in a small town, for some reason there is an increased demand for potatoes. Retail stores will find that they are selling more potatoes than used to. They will order more potatoes from wholesaler. The wholesaler will order more potatoes from suppliers—farmers. In order to satisfy the increased demand, the wholesaler will pay higher price to induce farmers to plant more potatoes. The higher price is an incentive, so the farmers improve their work efficiency and increase work force to supply the higher demand of potatoes. In this way, the information that there is an increased demand for potatoes transmits around the society. In this process, prices play a role as vehicle. There is one point need to note that for what reason the demand for potatoes increased is not quite important. I will discuss this problem below.

Prices have central place in economics, because prices contain and convey information. First of all, prices convey relative information. In the economy market, a single price is virtually useless. If there are no other prices which you can compare with, the price is uninformative, because prices are a source of relative information about different goods and services. For example, suppose that in a small town the price of a pound of potatoes is one pound and you do not know any other prices about goods, you can not judge the potato is expensive or cheap, because that is a ...

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Second, prices convey relevant information. That means price mechanism convey only the important information to the people who need to know. In the market, information is dispersed among many people; prices can coordinate separate action of different people. Prices convey information necessary to make comparisons and decisions about goods and services. The Australian economist F.A Hayek described this aspect of price mechanism in a 1945 article “The Use of Knowledge in Society”:

“In a abbreviated from, by a kind of symbol, only the most essential information is passed on and passed on only to those concerned. The whole acts as one market, not because any of its member survey the whole filed, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all.”

For example, the farmers do not need to know why the demand of potato increases. They do not even need to know the demand for potatoes has increased, because those details are not relevant to their decisions about how much to plant. All that is important to them is to know that someone willing to pay more for potato and they will make more profits by supply more potatoes. Based on that information, they have an incentive to plant more potatoes.

Third, in the process of information transmission, price mechanism plays an important role to make information efficiency. The people of firm who convey the information have an incentive to take the right action on the basis of that information. The wholesaler is connecting with farmers who can plant potatoes he needs. He is always trying to search out more suppliers who can offer him a lower price. At the same time, the farmers are always trying to find new wholesaler who can pay them higher price or have greater demand for potatoes. In this process, people who have on interest in potatoes will ignore these information

Information conveyed by market prices is necessary to use scarce resources efficiency. The price mechanism determines what is produced, how to produce it and whom to produce it for. Now I will explain how the information causes the market efficiency.

Price mechanism determines what is produced. People spend their incomes on goods and services they want, these information transmitted by price mechanism, therefore prices reflect the demand. These information tell producers what people want and through the price system they decide what to produce. In this way, producers will not spend money and work force on goods and services which people do not want. They have minimized their costs, in other words, scarce resources are used best. Imagine that, in the small town, people have an increased demand for potatoes and a decreased demand for tomatoes. The price of potatoes will rise and the price of tomatoes will fall. This information reflects a person really wants. The producers—farmers get this information, for the aim that maximize profits and minimize costs, they will reduce the field of tomatoes and increase the field of potatoes. The scarce oil resources utilize efficiently.

Once a firm has decided what to produce it must decide how to produce it. Price mechanism provides an incentive to act on information about the most efficient way to produce a product. Resources will never be wasted producing a given input. The firm will never use 10 units of capital when they could produce the same product with half these inputs. They will find the most efficient way, such as the efficiency equipment and reasonable work force distribution to produce the output. For example, because the land resources are limited, but demand for potatoes is increased, farmer will find more efficient way to plant potatoes. Because work force is more and more expensive, the farmer will consider how to use their workforce effectively. In this way, labour resources are used best.

Price mechanism can make scarce resources efficiency in another way. For some reason, perhaps the bad weather, the supply of potatoes decreased. Basic supply and demand analysis tells us that the price of potatoes will rise. People who buy the potatoes will never waste it because the price of potatoes is expensive.

Therefore it can be seen that the price mechanism serves as an invisible hand which guide people search profit and efficiency.

However, sometimes price mechanism can not transmit information correctly; the information may distort by other aspect, for example, government intervention. The government intervene the market system through tariffs and other restraints on various market activities. When the price of a good suddenly rises, people can not judge whether there has an increased demand, because it may be led by government. But we should believe that the government interventions could make everyone better off if government officials had right incentives.

In conclusion, prices convey the most important information. The price mechanism plays an allocative role in the market economy, it determines what to produce, for whom to produce it and how to produce it. People can examine the prices of all of the inputs relevant to their production processes, then choose the input mix that produces the output at the lowest cost. In this way, market prices allow producers to react to consumer preferences and put resources to their vest use. Both economic and technical efficiency are achieved which means that not only the minimum wastage of resources but also resources are used to their most valuable use namely economic efficiency.

References

The Role Of Prices

The Price Mechanism

Market Prices Versus Government—Controlled Prices

By Edward W. Younki

http://www.quebecoislibre.org/020216-15.htm

Information, Prices, and Socialism’s Flaw

http://www.econlib.org/library/columns/teachers/information.html