Functions of Price
1. Resource Distribution: In the market, it acts as signals that denote changes in demand and companion resource allocation. A good or service’s price increase tells producers that there is a greater demand for it, which motivates them to devote more resources to producing it.
2. Rationing Mechanism: In times of scarcity, prices also serve as a rationing mechanism. It increases when there is a shortage of a certain commodity or service, which motivates users to use those resources more wisely and may discourage over-indulgence. On the other hand, decreased prices during periods of plenty indicate abundance and free up resources for other purposes.
3. Incentives for Production: They serve as a strong motivator for producers to raise their output. Producers are encouraged to increase output to take advantage of the increased earnings that are available when prices rise. To satisfy customer demand, resources must be used effectively, which is ensured by the link between prices and production levels.
4. Information Transmission: In the market, prices are a means of information transmission. They transmit important information regarding shifts in consumer preferences and manufacturing costs, as well as the relative abundance or scarcity of commodities and services. While producers utilize price information to modify their production levels and plans, buyers use price signals to make well-informed judgments about what to purchase.
5. Profit Motive: Prices are a key factor in how businesses behave because they are motivated primarily by profit. It determines income and expenses, which in turn affect a company’s capacity to turn a profit. Businesses are encouraged to innovate, work efficiently, and invest in expansion prospects by attractive pricing points.
6. Market Clearing: To achieve a market state where supply and demand are equal, prices are important. It often declines when there is an excess supply, which increases demand and promotes consumption until an equilibrium is reached. On the other hand, when demand is higher than supply, prices rise and producers may be encouraged to raise output until the market is back in balance.