The basic reason for all this is that price mechanism brings about co-ordination in various sectors of economy and in various economic activities. The important characteristic of such a system is that it is automatic and there is no institution or agency which regulates or operates it.
The basis of price mechanism is that every commodity or service has a price which is determined with the help of supply and demand. Every commodity is bought and sold through money. If a person sells his services or commodity, he gets money and in lieu thereof he can buy goods and services which he needs. If there are more buyers of a commodity, its demand goes up and producers increase its production.
On the other hand, if a commodity is available in abundance, its supply increases, with the result its price goes down and producers reduce its production. Whenever there is a difference or disequilibrium between supply and demand, price starts changing, with the result this difference disappears and again an equilibrium is established between supply and demand.
demand and supply curves intersect each other at point E where price is OP and equilibrium output OQ. According to the schedule equilibrium price will be Rs. 10 because at this price demand and supply are equal.
In a capitalist economy, all the central problems are solved with the help of price mechanism. Now we would sec as to how all the central problems—what to produce, how to produce and for whom to produce—arc solved with the help of price mechanism.
1. What to produce?
In a capitalist economy, production of a commodity is decided by the forces of demand and supply. As the production of a commodity depends upon its demand and...