Prices of goods, as has been stated already, express the exchange value. These are also used for expressing the value of various services rendered by different factors of production such as land, labour, capital and organisation. The values are: rent, wages, interest and profit. Therefore, the concept of price especially the process of price determination, is of vital importance in Economics.
Exchage value or money value, known as price, depends on two elements, utility and scarcity. Water and air have got immense value in use but, since they are not scarce, they do not have exhange value unless, of course in certain special circumstances they also become scarce. On the other hand, alcoholic drinks are scarce in relation to the demand but a tee-totaller has no utility for them and he, in consequence, is not inclined to pay any price for them, except out of the motive for resale.
These are certain therories which have emphasised one or the other of the aspects as the chief factor requiring consideration for determining value. Classical economists asserted that value is depedent on the cost of production which includes normal amount of profit that an entrepreneur is expected to earn. Adam Smith, Ricardo and Karl Marx were of the view that out of all costs of production, it was labour which was the most important and hence according to them the value of a commodity is determined by the cost of labour incurred in its production.
As against the above view, certain economists like Walras asserted that the value of a product is determined by its marginal utility.
As a matter of fact, value is dependent of both cost of production and utility. Cost of production of a product helps in determining its supply and its marginal utility to the consumer helps in determing the demand for it. The actual price of the commodity well be fixed at a point where demand for the product is equal to its supply.
It is to be noted that generally it is the interaction between demand and supply that determines the price but sometimes government intervenes and determines the price either fully or partially. For example, the Government of India fixes up prices of petrol, diesel, kerosene, coal, fertilizers, etc. which are critical inputs. It also fixes up procurement prices of wheat, rice, sugarcane, etc. in order to protect the interests of both producers and consumers. While determining these prices, the government takes into account factors like cost of inputs, risks for business, nature of the product etc.
Price Mechanism
Free Economy
Free economy is one is which the forces of demand and supply have a free interplay and, through their interaction, a price is determined which is fair to all the parties concerned. In such an economy the decisions of millions of people in their capacities as producers, sellers, consumers, buyers, workers or financiers, are guided by the market forces of demand and supply which get free expression through the price mechanism; and the inter-play of economic forces bring about a state of equilibrium. At the equilibrium price all the sellers are able to find buyers and all the buyers are able to find sellers. If the market price is above equilibrium, some seller are not able to find buyers in consequence, the price is reduced conversely, if the price is lower than the equilibrium price, the buyers raise their prices.
In a free economiy, market plays a dual role that of determining the prices of different commodities on the basis of their quantities that are available for supply and the demand for them and, second which is a corollary of the first, of bringing about an equilibrium between the demand and supply of various goods and services.
In the field of production prices of various commodities in the market and their trend of rise of fall helps producers to decide which of the articles, and in what quantities, it would be beneficial for them to produce. The trend of the prices indicates the relative preferences of consumers. No producer can afford to neglect the vote of consumers expressed in their price bids for the commodity. Similarly, prices of factors of production help producers in making a choice of factors which would be most beneficial for them to employ. With the help of the two prices, they can make a rough estimate of the likely profits they will be able to earn out of their productive efforts. With this data producers can make an appropriate choice of production technology which would ensure them the maximum net return. In case a producer finds that the likely net return in a particular form of production will be less than the transfer earning of the assets elsewhere, he would decide to switch over to new lines of production. Since such calculations are continually made by a vast multitude of business-men working in the field of production, only the most efficient producers survive, those who are inefficient are eleiminated automatically in the race or survival of the fittest.
In the field of consumption, the relative prices of goods quoted in the market help a consumer in making the best possible choice of the combination of goods which, with a given consumer preference, will give him the maximum satisfaction for the money he spends. In a free economy, the consumer is considered to be king because he has vast discretion and freedom in the choice of goods. Within the limits of his resources, he can freely bargain for price and exert his influence in bringing down the price to his best advantage.
In the field of exchange, price mechanism has the effect of extending the market and facilitating the exchange of both goods and services. Price mechanism enables goods to move to the dearest buyer while the cheapest seller has an advantage over others. In consequence, goods automatically move towards those markets where prices are higher and where there is relative scarcity and there is greater need for the goods.
In the field of distribution, the pricing of different factors of production helps in the proper distribution of national product. On the one hand, it ensures proper reward to each factor of production and, on the other every producer is in a position to choose the factors which would give him the maximum return in the productive process.
Controlled Economy
In this case what should be produced, and in what quantities it should be produced, is decided by the planning body, set up by the State assessing the preferences of the people. Thereafter, the quantities produced are rationed within the limits. When the economy is large, people’s requirements cannot be ascertained directly. Imagine the time and effort it would require to find out from millions of people how much each person requires of the different kinds of commodities and services that the country is in a position to provide.
Social effects of the operaion of price mechanism: Though there are several advantages of price mechanism, it does not always operate equitably and justly. In a society ridden with inequalities of income and wealth, free and fair competition is not practicable. The rich consumers are in a position to offer higher prices for the goods they require; thereby they raise their prices which has the effect of directing the productive resoures into channels which best serve the well-to do sections of the community. In consequence, non-essential needs of consumers who are rich are catered to in preference to the basic needs of the common man.
Similarly, in the field of distribution, in the absence of a proper bargaining power, workers are not given the wage equal to the contribution made by them.
Due to these basic inequalities in the economic structure, the free working of market forces has let to several evils which afftect the economic and social life of the poor people. On this account, the operation of free market is totally or partially regulated an controlled by Government by the introduction of several fiscal, monetary and other measures.
Mixed Economy
In a mixed economy the endeavour is to evolve a system which tries to include the best features of both the controlled economy and the market economy while avoiding the demerits of both. India is the best example of such type of system.
Features of a mixed economy: The first important feature of a mixed economy is the co-existence of both private and public enterprise. In fact, there are three sectors of industries in a mixed economy.
Private Sector: Production distribution are mangaed and controlled by private individuals and groups. Industries in this sector are based on self-interest and profit motive. The system of private property exists and personal initiative is given full scope, however, private enterprise may be regulated by the goverment directly and or indirectly by a number of policy instruments.
Public Sector: Industries in this sector are not primarily profit oriented but are set up by the State for the welfare of the community.
Combined Sector: A sector in which both the government and the private enterprises have equal access and join hands to produce a commodity, leading to the establishment of joint sectors.
Secondly, a mixed economy is an economy in which the government has a clear and definite plan. Public sector enterprises have to work according to a plan and to achieve the objectives laid down. The government has also to create necessary atmosphere for the private sector to develop on its own. Thus it must prepare plans of developments for both the private and the public sector enterprises.
Pricing in a mixed economy: In a mixed economy, a dual system of pricing exists. In the private sector, prices of goods and factors of production are determined through the free play of market forces of demand and supply.
In the public sector, the State has the authority to determine prices of products produced by its units. It has the choice of setting different prices for public sector units and private sector unit using its product. For example, the Steel Authority of India charges one set of prices from Indian Railways and another from the private users of steel.
Besides, the State can also fix the prices of certain essential commodities. These are called ‘administered prices’. For example in India, the prices of essential commodities like petrol, diesel, kerosene, coal, electricity and railway transport are fixed by the Government. Generally, while fixing these prices, the Government takes into account factors like cost of inputs, risk of business, requirement for product etc.
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