According to BuisnessDictionary.com, Price mechanism is defined as , System of interdependence between supply of a good or service and its price. It generally sends the price up when supply is below demand, and down when supply exceeds demand. Price mechanism also restricts supply when suppliers leave the market due to low prevailing prices, and increases it when more suppliers enter the market due to high obtainable prices.’ Next, capitalistic Economy is defined as, ‘Economic system based (to a varying degree) on private ownership of the factors of production (capital, land, and labor) employed in generation of profits. It is the oldest and most common of all economic systems and, in general, is synonymous with free market system.’

Over the next course of this project, examples of how capitalist economy will be explained and how the price mechanism works for them .

How price mechanism works in a capitalistic economy

In a capitalist economy, all the central problems are dealt with the assistance a of price mechanism. In such an economy, no individual or firms deliberately tries to solve the central problems, instead all economic activities operate automatically and there are no conflicts anywhere to be found.

The main reason for all this is so that the price mechanism brings about coordination in various sectors of an economy system and in certain economic activities. The important or main characteristic of such a system is that it is automatic and independent and there are no institutions or agencies which may regulate or operate it.

The basis of price mechanism is that every commodity or service has a price in which it is determined with the help of demand and supply. Every commodity is dealt through buying or selling through a medium of currency (money). If a person sells his services or commodity, he gets money and with that he can buy goods and services which he needs. If there are more buyers of a product/commodity, its demand goes up and producers increase its production.

On the other hand, if a commodity is available in surplus, its supply increases, with the result its price shoots down and producers will therefore reduce its production. Whenever there is a difference or disequilibrium between supply and demand, price starts changing (either by going up or down), with the result this difference disappears and again an equilibrium is established between supply and demand.

In a capitalist economy, all the central problems are solved with the assistance of a price mechanism. Most central problems are dealt or can be asked through ‘Wh’ questions as in What, How , Whom etc. For example: –

What to produce?

In a capitalist economy, production of goods are decided by the forces of demand and supply. As the production of goods depends upon its demand and supply, in the same way as how an aggregate output is determined by an aggregate demand and an aggregate supply. The level of output where aggregate demand and aggregate supply are equal and is finally determine as an equilibrium output.

Also, In an aggregate output, what should be the quantities of different commodities? This decision is also made by the equilibrium of demand and supply of different commodities. The production of the commodity is increased when price goes up as a result of increase in its demand. On another hand, if the demand of a commodity declines, the production is then reduced.