The Importance of Prices in Economic System
THE IMPORTANCE OF PRICES IN ECONOMIC SYSTEM
A price is the amount of money a buyer must pay to a seller for a good or service. Price is not always the same as cost. In economics, cost means opportunity cost—all that is sacrificed to buy the good. While the price of a good is a part of its opportunity cost, it is not the only cost. For example, the price does not include the value of the time sacrificed to buy something. Buying a new jacket will require you to spend time traveling to and from the store, trying on different styles and sizes, and waiting in line at the cash register. Still, in most cases, the price of a good is a significant part of its opportunity cost. For large purchases such as a home or automobile, the price will be most of the opportunity cost. And this is why prices are so important to the overall working of the economy: they confront individual decision makers with the costs of their choices. Consider the example of purchasing a car. Because you must pay the price, you know that buying a new car will require you to cut back on purchases of other things. In this way, the opportunity cost to society of making another car is converted to an opportunity cost for you. If you value a new car more highly than the other things you must sacrifice for it, you will buy it. If not, you won’t buy it.
Why is it so important that people face the opportunity costs of their actions? The following thought experiment can answer this question. Imagine that the government passed a new law: When anyone buys a new car, the government will reimburse that person for it immediately. The consequences would be easy to predict. First, on the day the law was passed, everyone would rush out to buy new cars. Why not, if cars are free? The entire stock of existing automobiles would be gone within days—maybe even hours. Many people who didn’t value cars much at all, and who hardly ever used them, would find themselves owning several—one for each day of the week, or to
A price is the amount of money a buyer must pay to a seller for a good or service. Price is not always the same as cost. In economics, cost means opportunity cost—all that is sacrificed to buy the good. While the price of a good is a part of its opportunity cost, it is not the only cost. For example, the price does not include the value of the time sacrificed to buy something. Buying a new jacket will require you to spend time traveling to and from the store, trying on different styles and sizes, and waiting in line at the cash register. Still, in most cases, the price of a good is a significant part of its opportunity cost. For large purchases such as a home or automobile, the price will be most of the opportunity cost. And this is why prices are so important to the overall working of the economy: they confront individual decision makers with the costs of their choices. Consider the example of purchasing a car. Because you must pay the price, you know that buying a new car will require you to cut back on purchases of other things. In this way, the opportunity cost to society of making another car is converted to an opportunity cost for you. If you value a new car more highly than the other things you must sacrifice for it, you will buy it. If not, you won’t buy it.
Why is it so important that people face the opportunity costs of their actions? The following thought experiment can answer this question. Imagine that the government passed a new law: When anyone buys a new car, the government will reimburse that person for it immediately. The consequences would be easy to predict. First, on the day the law was passed, everyone would rush out to buy new cars. Why not, if cars are free? The entire stock of existing automobiles would be gone within days—maybe even hours. Many people who didn’t value cars much at all, and who hardly ever used them, would find themselves owning several—one for each day of the week, or to