Question

Explain why it is important that prices are flexible in our economy? What are the implications if the government started to control prices for products, how would this influence buying?

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Answer 1

Prices must be flexible in an economy because flexible prices are decided by the free play of the demand and supply variables in the market and hence it is appropriate for everyone in the economy. Flexible prices are mostly found in a competitive market and hence the flexibility of the price helps the firms to innovate new products and technology. If they develop a new product by incurring a large cost on research and development, so they will obviously charge a higher price for it to recover their cost. But if the prices are same for the old products and the new product so there will be loss to the firm who incurred cost on development of the product. So the prices must be flexible in the market which may be different for different quality of goods.

If government started to control prices for a product there will be some implications associated with it, as the fixation of prices may lead to a loss for either the producer/supplier or the consumers/buyers. If the prices are set higher there will be loss to the consumer and if set lower there will be loss to buyers. The other implication of price fixation will be the loss of competitiveness among the producers of the commodity and demotivation for research and development work.

Government mostly controls prices in favour of the consumers. They impose price ceiling and price flooring according to the nature of the commodity. For the merit goods which needs to be consumed by everyone but some people can't afford to buy it due to high price, go ernment imposes a limit on the highest price that can be charged by the seller and if at that price there is loss to the producer than government provides subsidy to them. So it can be clearly said that in most cases price control by the government leads to increase in consumption of goods and services because they decrease their price.