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Encyclopedia > Free price system

A free price system or free price mechanism (informally called the price system or the price mechanism) is an economic system where prices are not set by government or a central planning board but by the interchange of supply and demand, with the resulting prices being understood as signals that are communicated between producers and consumers which serve to guide the production and distribution of resources. Through the free price system, supplies are rationed, income is distributed, and resources are allocated. A free price system contrasts with a controlled or fixed price system where prices are set by government, within a controlled market or planned economy. The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). ... In economics, incomes policies are wage and price controls. ... This article refers to an economy controlled by the state. ...

Mechanics of a free price system

A diagram presenting the argument for free prices

Rather than prices being set by the state, as in a command economy with a fixed price system, prices are determined in a decentralized fashion by trades that occur as a result of sellers' asking prices matching buyers' bid prices as a result of subjective value judgement in a market economylike ebay. Since resources of consumers are limited at any given time, consumers are relegated to satisfying wants in a descending hierarchy and bidding prices relative to the urgency of a variety of wants. This information on relative values is communicated, through price signals, to producers whose resources are also limited. In turn, relative prices for the productive services are established. The interchange of these two sets of prices establish market value, and serve to guide the rationing of resources, distributing income, and allocating resources. Image File history File linksMetadata Download high resolution version (976x824, 688 KB) Summary Copied from Free Enterprise - Why? by Leonard W. Martin, The Freeman June 1958, Foundation for Economic Education. ... Image File history File linksMetadata Download high resolution version (976x824, 688 KB) Summary Copied from Free Enterprise - Why? by Leonard W. Martin, The Freeman June 1958, Foundation for Economic Education. ... A planned economy is an economic system in which economic decisions are made by centralized planners, who determine what sorts of goods and services to produce, and how they are to be priced and allocated. ... Economic subjectivism is the theory that value is a feature of the appraiser and not of the thing being valued. ... A market economy (also called a free market economy or a free enterprise economy) is an economic system in which the production and distribution of goods and services take place through the mechanism of free markets guided by a free price system. ...

Those goods which command the highest prices (when summed among all individuals) provide an incentive for businesses to provide these goods in a corresponding descending hierarchy of priority. However, the ordering of this hierarchy of wants is not constant. Consumer preferences change. When consumer preferences for a good change, then bidding pressure raises the price for a particular good as it that moves to a higher position in the hierarchy. As a result of higher prices for this good, more productive forces are applied to satisfying the demand driven by the opportunity for higher profits in satisfying this new consumer preference. In other words, the high price sends a price signal to producers. This causes producers to increase supply, either by the same firms increasing production or new businesses coming in to the market, which eventually lowers the price and the profit incentive to increase supplies. Hence, the now lower price provides a price signal to producers to decrease production and, as a result, a surplus is prevented. Since resources are scarce (including labor and capital), supplies of other goods will be diminished as the productive resources are taken from other areas of production to be applied toward increasing output of the good who has risen in the hierarchy of consumer preferences. Also, as resources become more scarce the price increases, which signals to consumers to reduce consumption thereby ensuring that the quantity demanded does not exceed the quality supplied. It is in this way that the free price system persuades consumers to ration dwindling resources. Hence, supply and demand affects price while at the same time, price affects supply and demand. If prices remain high because increases in supply cannot keep pace with demand, then this also signals other business to provide substitute goods in order to take advantage of profit opportunities.

Individual employments and incomes are also guided by the price system. Employment will move toward those goods and services that consumers value and away from those with declining importance to consumers as a result of changes in prices.


  • Martin, Leonard W. Free Enterprise - Why?, The Freeman, The Foundation for Economic Education, June 1958.
  • Hazlitt, Henry. How the Price System Works

See also



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