What is the function of price in a free market economy?

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Price functions as a reflection of supply and demand in a free market economy. For example, if you want to buy a pack of gum, and there are lots of packs of gum available, the price will remain low, because there are plenty of packs of gum available to satisfy demand for the product. However, if there were suddenly a gum shortage and many people wanted to buy gum but could not find it, the price of the remaining packages of gum would go up.

In addition, price influences supply and demand in a market economy. If a seller sets the price of a product too high, demand for the product will be low because no one will want to pay the price for the product. There will be too much product remaining, and the seller will need to reduce the price. If a seller sets the price of a product too low, the demand will be too high, and the product will sell quickly. In order to capitalize on the increased demand for the product, the seller will need to raise the price.

The constant shifting of price as a regulator of supply and demand is one of the hallmarks of a free market economy.

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Price plays a very important role in a free market economy. Price indicates if resources are being properly allocated. If the price is too low, there will be a shortage of products. Demand will be greater than supply. This will indicate that more resources should be allocated to the manufacturing of the product. If the price is too high, there will be a surplus of products. Supply will be greater than demand. This will suggest that too many resources are being allocated toward the manufacturing of the product.

When supply and demand are equal, profit will be maximized. There won’t be too many items going unsold. There also won’t be the loss of income because too few items were produced. To maximize efficiency, producers need to determine the price where demand and supply are relatively equal.

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In a free market economy the price of different products gives information about the demand and supply of the products. The price of products increases when the demand rises as there are more buyers willing to pay a larger amount for the same product. Price also goes up when the number of producers supply a smaller amount of the product as they are in a position to demand a larger amount for the same product.

The demand and supply in a free market is also a function of the price. As the price increases the demand goes down and the supply increases. On the other hand when the price goes down the demand rises and the supply decreases. The result of this feedback loop is the determination of an equilibrium price at which the buyers are willing to buy a particular quantity of the product and sellers are willing to sell the same quantity of the product.

Adam Smith is widely believed to be a proponent of the free market economy where competition drives prices up or down and the government has no role to play either in controlling prices or in helping producers. A more detailed study of his writing reveals that this is not the case and he in fact believed that governments should intervene when required to protect producers, buyers and keep prices within reasonable limits.

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