Price System or Price Mechanism

CONTENTS:

1.         The concept of price system or price mechanism

2.         Factors that determine price of commodities

3.         Government interventions in the market

4.         Price control

NOTES:

PRICE SYSTEM OR PRICE MECHANISM

In a free market economy prices of goods and services affect the behaviour of both the consumer and the producer (supplier) Price system maybe defined as a system whereby prices of goods and services are determined by the free interaction of the forces of demand and supply in a free market economy.

FUNCTIONS/IMPORTANCE OF THE PRICE SYSTEM

1.         The price system operates to allocate scarce resources

2.         It regulates the flow of goods and services from producers to the consumer.

3.         It determines the extent of demand and supply of goods and services.

4.         It is used to encourage or discourage consumption of certain goods and services.

5.         It helps to determine how the factors of production will be rewarded.

FACTORS THAT DETERMINE PRICE OF COMMODITIES

a.         The cost of production of the product

b.         The level of profit desired by the seller

c.         The level of competition in the market

d.         Government policies e.g subsidies, taxation etc.

e.         The activities of Trade Unions

f.          The cost incurred on advertisement

g.         Changes in demand and supply

GOVERNMENT INTERVENTIONS IN THE MARKET

Sometimes government intervenes in the market through subsidies and direct price control.

a.         SUBSIDIES: Government may pay a part of the cost of certain products on behalf of the consumer.  This is usually in the form of granting concessions to the producers to assist them in cutting production costs e.g through the reduction of import duties on inputs – machinery or raw materials.

b.         PRICE CONTROL: Price control defines a situation where the government uses the instrument of law to fix the price of certain commodities.  It can be in the form of maximum or minimum price control.

i.          Maximum price control: This is practiced when government wants to protect consumers against suppliers (sellers).  The government will set a maximum price below the market equilibrium price of the commodity.

Effects of a maximum price control policy

a)         Hoarding of goods

b)         Stimulation of demand i.e. excess demand, which cannot be satisfied.

c)         Shortages of goods in the market

d)         Queues for the good concerned

e)         Black market dealing/under –counter sales

f)         Reduction in supply

g)         Rationing of the good

h)         Favoritism, bribery and corruption

ii)         Minimum price control:  This happens when the government wants to protect infant industries or inefficient home producers against outside competition.  The government will set a minimum high price above the market equilibrium price for the good and in addition may also saddle importers with a high duty.

The increase in price will however reduce demand and create a surplus in the market.  The government will then step in again to buy up the surplus goods and store them to meet the shortages in supply in the future

OBJECTIVES OF PRICE CONTROL POLICY

1.         To prevent exploitation of consumers by producers and sellers

2.         To avoid or control inflation

3.         To help low income earners e.g the minimum wage policy

4.         To control the profits of companies –especially monopoly.

5.         To prevent fluctuations of prices of some products e.g agricultural produce.

6.         To stabilize the income of some producers e.g. farmers.

7.         To enhance possible planning for future output.

EVALUATION QUESTIONS

1.         List two importance of the price system.

2.         Explain how government policy and taxation can affect price determination.

3.         What is the effect of maximum price control on the equilibrium price of a commodity.     Explain with a diagram.

 READING ASSIGNMENT

1.         Comprehensive Economics for SSS by J. U. Anyaele Page 178 – 183

 WEEKEND ASSIGNMENT

1.         The gap between demand and supply curves below the equilibrium price indicates

(a) excess demand (b) excess supply (c) equilibrium quantity (d) equilibrium price.

2.         Which of the following is not an advantage of price control (a) control of inflation

(b) distortion of price mechanism (c) prevention of exploitation

(d) control of producer’s profit especially monopoly.

3.         The price system refers to the system by which (a) the government control prices in the economy (b) prices tend to rise to a general level (c) price allocates resources between consumer and producer goods (d) the producers fix the price of their products.

4.         When the price of a commodity is fixed by law either below or above the equilibrium the mechanism is known as (a) price discrimination (b) equilibrium price (c) free market (d) price control.

5.         The price system is (a) the market price of commodities (b) a system of price allocation to the products of the same firm (c) a system of resources allocation through supply and demand interactions (d) a market where a single price rules.

THEORY

1.         State three factors that determine the price of commodities.

2.         List three objectives of price control.