Price signal
Encyclopedia
A price signal is a message sent to consumers and producers in the form of a price charged for a commodity
; this is seen as indicating a signal for producers to increase supplies and/or consumers to reduce demand.
, rising prices may indicate a shortage
of supply
, increase in demand
, or a rise in input costs. Regardless of the underlying reason—and without the consumer needing to know the cause—the price increase communicates the notion that consumer demand (at this new, higher price) should recede or that supplies should increase. Consumers that do continue to purchase the product at the higher price ostensibly give the product a higher marginal utility
. This results in a natural market correction, according to the Austrian theory of catallactics
.
An alternative theory of centrally planned economies, the shortage economy
theory of Hungarian economist János Kornai
argues that it is not a failure of the pricing mechanism, but rather a systemic failure to produce enough goods, since shortages were obvious but persisted.
s are set is a key question in the theory of industrial organization
. The theory of price signals argues that higher prices reflect either increased consumer demand (thus spurring higher production), or increased producer costs (thus reducing consumption), allowing the coordination of the economy. For example, if a producer charges a fixed percentage markup
, then prices reflect costs of production, and changes in price correspond to changes in production, rather than changes in profit.
may set prices so as to maximize monopoly profit
, regardless of actual costs of supply or demand, while a cartel
may engage in price fixing
. Conversely, on the consumer side, a monopsony
may negotiate or demand prices that do not reflect actual demand or cost of production.
through classical economics
into the present) distinguishes between exchange value
, use value
, price, and (sometimes) intrinsic value
. It is frequently argued that the connection between price and other types of value are not as direct as suggested in the theory of price signals, with other considerations playing a part.
Notably, in Marxian economics
, the setting of prices is analyzed in the Law of value
, which argues among other points that prices charged and wages paid do not reflect the labor value involved in production.
– particularly buying or selling assets with borrowed money – can result in prices varying significantly from their economic fundamentals
; it is generally accepted that credit bubbles can sometimes distort the price signal mechanism, causing large-scale malinvestment and financial crises. Adherents of the heterodox economic
school known as Austrian economics attribute this phenomenon to the interference of central bank
ers, which they propose to eliminate by introducing full-reserve banking
, while the post-Keynsian economists
such as Hyman Minsky
have described it as a fundamental flaw of capitalism, to be corrected by financial regulation
. Both of these schools have been the subject of renewed attention in the Western world since the financial crisis of 2007–2010.
Commodity
In economics, a commodity is the generic term for any marketable item produced to satisfy wants or needs. Economic commodities comprise goods and services....
; this is seen as indicating a signal for producers to increase supplies and/or consumers to reduce demand.
Free price system
For example, in a free price systemFree price system
A free price system or free price mechanism is an economic system where prices are set by the interchange of supply and demand, with the resulting prices being understood as signals that are communicated between producers and consumers which serve to guide the production and distribution of...
, rising prices may indicate a shortage
Economic shortage
Economic shortage is a term describing a disparity between the amount demanded for a product or service and the amount supplied in a market. Specifically, a shortage occurs when there is excess demand; therefore, it is the opposite of a surplus....
of supply
Supply (economics)
In economics, supply is the amount of some product producers are willing and able to sell at a given price all other factors being held constant. Usually, supply is plotted as a supply curve showing the relationship of price to the amount of product businesses are willing to sell.In economics the...
, increase in demand
Demand (economics)
In economics, demand is the desire to own anything, the ability to pay for it, and the willingness to pay . The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time....
, or a rise in input costs. Regardless of the underlying reason—and without the consumer needing to know the cause—the price increase communicates the notion that consumer demand (at this new, higher price) should recede or that supplies should increase. Consumers that do continue to purchase the product at the higher price ostensibly give the product a higher marginal utility
Marginal utility
In economics, the marginal utility of a good or service is the utility gained from an increase in the consumption of that good or service...
. This results in a natural market correction, according to the Austrian theory of catallactics
Catallactics
Catallactics is the praxeological theory of the way the free market system reaches exchange ratios and prices.It aims to analyse all actions based on monetary calculation and trace the formation of prices back to the point where an agent makes his or her choices. It explains prices as they are and...
.
Fixed price system
In a fixed price system where prices are set by government, price signals may not be as reliable as indicators of shortages, surpluses, or consumer preferences according to opponents of planned economies. These artificial prices may create shortages and surpluses that would not occur under a free price system.An alternative theory of centrally planned economies, the shortage economy
Shortage economy
Shortage economy is a term coined by the Hungarian economist, János Kornai. He used this term to criticize the old centrally-planned economies of the communist states of the Eastern Bloc...
theory of Hungarian economist János Kornai
János Kornai
János Kornai , is an economist noted for his analysis and criticism of the command economies of Eastern European communist states.- Biography :...
argues that it is not a failure of the pricing mechanism, but rather a systemic failure to produce enough goods, since shortages were obvious but persisted.
Alternative theories
How pricePrice
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
s are set is a key question in the theory of industrial organization
Industrial organization
Industrial organization is the field of economics that builds on the theory of the firm in examining the structure of, and boundaries between, firms and markets....
. The theory of price signals argues that higher prices reflect either increased consumer demand (thus spurring higher production), or increased producer costs (thus reducing consumption), allowing the coordination of the economy. For example, if a producer charges a fixed percentage markup
Markup (business)
Markup is the difference between the cost of a good or service and its selling price. A markup is added on to the total cost incurred by the producer of a good or service in order to create a profit. The total cost reflects the total amount of both fixed and variable expenses to produce and...
, then prices reflect costs of production, and changes in price correspond to changes in production, rather than changes in profit.
Pricing power
Alternative theories include that prices reflect relative pricing power of producers and consumers – for example, a monopolyMonopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
may set prices so as to maximize monopoly profit
Monopoly profit
- Monopoly Profit - Basic Definition :In economics, a firm is a monopoly when, because of the lack of any viable competition, it is able to become the sole producer of the industry's product. In a normal competitive situation, the price the firm gets for its product is exactly the same as the...
, regardless of actual costs of supply or demand, while a cartel
Cartel
A cartel is a formal agreement among competing firms. It is a formal organization of producers and manufacturers that agree to fix prices, marketing, and production. Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products...
may engage in price fixing
Price fixing
Price fixing is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand...
. Conversely, on the consumer side, a monopsony
Monopsony
In economics, a monopsony is a market form in which only one buyer faces many sellers. It is an example of imperfect competition, similar to a monopoly, in which only one seller faces many buyers...
may negotiate or demand prices that do not reflect actual demand or cost of production.
Value
A long thread in economics (from AristotleAristotle
Aristotle was a Greek philosopher and polymath, a student of Plato and teacher of Alexander the Great. His writings cover many subjects, including physics, metaphysics, poetry, theater, music, logic, rhetoric, linguistics, politics, government, ethics, biology, and zoology...
through classical economics
Classical economics
Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill....
into the present) distinguishes between exchange value
Exchange value
In political economy and especially Marxian economics, exchange value refers to one of four major attributes of a commodity, i.e., an item or service produced for, and sold on the market...
, use value
Use value
Use value or value in use is the utility of consuming a good; the want-satisfying power of a good or service in classical political economy. In Marx's critique of political economy, any labor-product has a value and a use-value, and if it is traded as a commodity in markets, it additionally has an...
, price, and (sometimes) intrinsic value
Value (economics)
An economic value is the worth of a good or service as determined by the market.The economic value of a good or service has puzzled economists since the beginning of the discipline. First, economists tried to estimate the value of a good to an individual alone, and extend that definition to goods...
. It is frequently argued that the connection between price and other types of value are not as direct as suggested in the theory of price signals, with other considerations playing a part.
Notably, in Marxian economics
Marxian economics
Marxian economics refers to economic theories on the functioning of capitalism based on the works of Karl Marx. Adherents of Marxian economics, particularly in academia, distinguish it from Marxism as a political ideology and sociological theory, arguing that Marx's approach to understanding the...
, the setting of prices is analyzed in the Law of value
Law of value
-General:The law of value is a central concept in Karl Marx's critique of political economy, first expounded in his polemic The Poverty of Philosophy against Pierre-Joseph Proudhon, with reference to David Ricardo's economics...
, which argues among other points that prices charged and wages paid do not reflect the labor value involved in production.
Speculation
It is also argued that financial speculationSpeculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
– particularly buying or selling assets with borrowed money – can result in prices varying significantly from their economic fundamentals
Fundamental analysis
Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. When applied to futures and forex, it focuses on the overall state of the economy, interest rates, production, earnings, and...
; it is generally accepted that credit bubbles can sometimes distort the price signal mechanism, causing large-scale malinvestment and financial crises. Adherents of the heterodox economic
Heterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...
school known as Austrian economics attribute this phenomenon to the interference of central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
ers, which they propose to eliminate by introducing full-reserve banking
Full-reserve banking
Full-reserve banking, also known as 100% reserve banking, is a banking practice in which the full amount of each depositor's funds are kept in reserve, as cash or other highly liquid assets...
, while the post-Keynsian economists
Post-Keynesian economics
Post Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, although its subsequent development was influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor and Paul Davidson...
such as Hyman Minsky
Hyman Minsky
Hyman Philip Minsky was an American economist and professor of economics at Washington University in St. Louis. His research attempted to provide an understanding and explanation of the characteristics of financial crises...
have described it as a fundamental flaw of capitalism, to be corrected by financial regulation
Financial regulation
Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system...
. Both of these schools have been the subject of renewed attention in the Western world since the financial crisis of 2007–2010.