Price signal

Price signal

A price signal is message sent to consumers and producers in the form of a price charged for a commodity; this is seen as indicating a signal for producers to increase supplies and/or consumers to reduce demand.

For example, in a free price system, rising prices may indicate a shortage of supply, increase in demand, or a rise in input costs. Regardless of the underlying reason—and without the consumer needing to know the cause—the price increase communicates the notion that consumer demand (at this new, higher price) should recede or that supplies should increase. Consumers that do continue to purchase the product at the higher price ostensibly give the product a higher marginal utility. This results in a natural market correction.

In a "fixed price system" where prices are set by government, price signals may not be as reliable as indicators of shortages, surpluses, or consumer preferences according to opponents of planned economies. These artificial prices may create shortages and surpluses that would not occur under a free price system. However, it can be argued that in general free market prices are not necessarily more reliable indicators than fixed prices; such is especially true when knowledge of the true values of goods is imperfect.

ee also

Free price system

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