How the Price System Works
This chapter focuses on the price system of various economic systems. The author believed that to study the effects of a given economic proposal effectively the immediate and long run results are necessary. This provides a clear picture of the economic system. This applies to the consequences where both the primary and secondary get considered and the effects of a group and not just a selected group of people.
There are various fallacies that economists have used to explain the price system. One particularly common school of though is “production for-Use-and-not-for-profit”. This view attacks the price system, and in the process, they solve the production problem which is responsible for creating currency cracks in the economy. The major cause of errors, according to the author, in analyzing the markets, price system and production is that some analysts tend to focus on only one industry or a group in isolations. This is wrong because all industries interrelate to each other and any decision made by one industry affects the other.
To understand the above theory, we consider a man in a desert island and the problems he encounters, for example, soaked, hungry, thirsty among others. He has many needs, but the means to meet this demand s limited. Thus, he has to prioritize the most pressing needs first at the expense of another less pressing need. This is the same scenario consumers’ experience. The demand for commodities is always greater than the supply ceteris paribus and needs are always more than the resources to satisfy them. Therefore, a consumer must forego a commodity for a more urgent one. This problem gets referred to as alternative application where he has to alternate his time and labor to meet the most urgent needs.
Businesses dominate in every industry. This means that it is the business and not the producers who determine how long a commodity will last in the market and at what price. Producers produce commodities and the businesses distribute it with the objective to maximize profit. If a commodity stops generating profit, businesses tend to abandon it and focus on another commodity irrespective of the consumers’ needs and demand.
An effective way to solve the problem is the division and specialization of labor. This means that the work gets divided into manageable parts, and different people handle specified tasks. This gives easier time for organizations to solve the problem of too many tasks that need to be completed. Division and specialization of labor also ensures that the commodities produced are quality and standard. This is because; once an individual specializes in one task they are able to focus all their energy to making it work hence producing quality work as compared to an individual who has to perform three tasks simultaneously. Specialization also helps managers to keep track of what each worker is doing and account for their productivity. This is convenient because it promotes accountability for both managers and the employees since every employee will be accountable for his/her own task. At the end, all the tasks get combined to complement each other making a complete process.
Another way of solving the problem of alternative applications of labor and capital is through the price system. This means the suppliers have to keep on constantly changing the interrelationship of the cost of production the profits and the prices of the commodity. This means that price gets determined by the level of supply and demand in the market. When a certain commodity x is in considerable demand, the supply gets increased, and the price automatically increases. This is because it becomes more profitable to produce more of commodity x than Commodity Y. contrarily this does not last because the economic system has to maintain equilibrium. Therefore, the price soon goes down causing a reduction in the profit margin. Thus, the marginal production will reduce. The producers get driven out of business as they are either inefficient, or their production costs are high. Producing individuals left are those producers whose output is of the highest quality and their operating costs are low. This means that the quantity supplied of commodity x will reduce. Once this happens, the price of the good increases and the demand equally increases. Leading to a continuous cycle since the market in a perfect competition has to be maintained at equilibrium always. Failure to maintain this condition could lead to market failure.( Hazlitt 89)
The above example shows that prices in the market get influenced by the demand and supply of a commodity. Demand, on the other hand, gets determined by how much consumers need the commodity and what they are willing to offer in exchange. As a result, supply gets determined by cost of production. As companies with high costs of production tend to increase the prices of their commodities. As a result, this could lead to people not buying from them in preference to other cheaper producers. This eventually draws the company out of business. However, it should be noted that the past cost of production of a commodity determines the value in the market. ( Raa 157)However, the expected production cost in the future compared to the future price determines the quantity that gets produced that is the future supply. Therefore, there exist a trend for the price of a commodity in the market and the cost of production to be equal. Although, this does not necessarily meant that the marginal production cost directly influences the market price of the commodity. (Hazlitt 93)
The private enterprise system can be equated to a system of machines each regulated individually by a quasi-automatic governor. However, at the end of the day, all the machines act like one powerful machine as they depend on one another. This means that each machine acts on its own but gets influenced by others. The same example can be used to explain the supply of different commodities in a competitive private enterprise system. When demand for a commodity x is high, marginal profit increases, and as a result of the increased demand the producers increase the supply. (Raa 181) The increase in supply can be attributed to more producers joining the market and stopping to produce the goods they were producing earlier. This creates a decrease in supply of other goods; hence their prices go up, increasing the marginal profit. This draws producers from producing more of good x and instead they resume production of the other goods since their demand is high and their profit margins are now high. (Hazlitt 91)
Critics do not agree that this theory is right. This is because they feel the producers only work towards profit maximization and not the utility of the consumers. This, they claim, results in scarcity of some commodities in the market. (Hazlitt 94)
When an economy is at equilibrium, the expansion of one industry gets done at the expense of another, in the same market. This is because; factors of production get limited and one industry expanding could only be achieved by diverting these factors employed in another industry. This means that industry will shrink at the expense of the expanding ones. However, it is not a must that production will reduce. It should be understood that successful production of a commodity gets done at the expense of something foregone. ( Raa 334)
Hazlitt, Henry. Economics in One Lesson. New York: Arlington House Publishers, 1979.Print.
Raa, Thijs . Input-output Economics: Theory and Applications: Featuring Asian Economies. Singapore: World Scientific, 2010. Print.