What is the function of prices in a market economy?

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gsenviro eNotes educator| Certified Educator

The price of a product gives an idea of its demand and supply in a market economy. If the price of the commodity goes up, its demand falls and supply will be in excess. Conversely, if the price falls, the demand would increase and supply would be in shortage. In either scenario, the suppliers will modify the supply to match the demand.

Similarly, price is affected by demand and supply. If the demand of a commodity rises, its price will also rise, since people are willing to pay a higher price for it. 

The price is also a determinant of resource distribution and resource discovery. For example, if the price of a commodity like oil goes up and supply is short, the oil will be used only for the most essential operations. This demand supply relation will also give rise to a search for oil alternatives and people will prefer more fuel efficient vehicles.