The market (price) system of resource allocation

This resource allocation system occupies a key
place in economics. Early economists (also called classical economists)
believed that the market system is the only system of allocation that
guarantees the best (optimum) utilization of resources. The market system works
through the relative prices of resources. A relative price is an indication of
how the price of a good compares to that of another. If three goods, say
orange, pear and pineapple, for example, cost N0.50,
N1.00 and N5.00 respectively in nominal prices, then it means that one pear
is equivalent to two oranges and one pineapple ten oranges.

Hence, the relative price of pear in relation to
orange is two oranges while the relative price of pineapple in relation to pear
is five pears. The higher the relative price of a commodity, the higher the
demand for that commodity and the greater the degree of scarcity associated
with the product. The price system is the whole set of relative prices that
provide information to buyers and sellers. The market system allocation
resources,  by providing information to
resource owners on the relative price of (and by transference the demand for or
level of scarcity of) individual goods and services.
The relative prices of goods and services help
the society (firm) to decide on what to produce. When a good has a high
relative price, it reveals that the society desires more of that good (i.e. the
demand far exceeds the quantity available). Hence, the society (firm) should go
into the production of that good. The utilization of society’s resources in its
production will yield the highest possible profit to the firm (since the
commodity commands the highest relative price) and at the same time create the
maximum welfare for the society (since it is the “scarcest” or most needed
commodity). The same analysis applies to the individual. The relative prices
attached to factor services (the services of an agriculturist in relation to
that of a lawyer, an accountant, an engineer or teacher etc.) will help an
individual to decide on what to develop his human resource to produce. If in
the society, the income of an engineer is greater than that of an
agriculturalist, then, it means that society’s demand for the former is greater
than the demand for the latter.
Engineers are scarce relative to agriculturist.
Basing his judgment on the information provided by the price system, in the bid
to maximize the use of his resources, the individual would decide to train as
an engineer. However, in pursuing his own selfish interest he would help to
maximize the welfare of the society (by increasing the number of engineers
available and hence reducing its relative scarcity). The price system also
helps to answer the question of how to produce and who gets what? If labor is
cheap relative to capital, for example, then capital is scarce relative to
labor.
Hence, the society (or firm) can minimize its
production cost by using more of labor and less of capital. Once the determined
output is produced, the price system ensures that they are allocated to those
who need them most and are ready to express that need in an effective demand
for the product at the market-determined price. Similarly, the individual in
our example would know what organization to offer his service by a
consideration of the relative prices. He would offer his services to the firm
that is ready to pay the highest price (given the relative scarcity of
engineers).
Hence, the price system ensures that businessmen
produce what is most needed by the society and that they are produced at the
minimum cost and are made available to those who desire them most. In other
words, the price system ensures that resources are allocated to their most
desired uses.

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