Question

2. Explain the following statement: “a price is a signal wrapped in an incentive.” Answer in six sentences or fewer. A complete answer should draw upon the supplementary readings

Answer 1

The statement: “a price is a signal wrapped in an incentive.” implies that price acts as a signal that helps to coordinate economic activity. In a free market, resources are allocated by price mechanism. The market participants allocate the limited resources across different goods in order to satisfy the needs & wants of large number of consumers as possible. So, price acts as a signal that helps market participants to allocate the resources to such uses which are highly valued by the customers so that they are able to earn highest possible incentives (profits). This price signal helps the market participants to allocate resources according to the tastes & preferences of the customers & by doing so they are able to earn huge incentives in the form of profits. The price of a good acts as a signal for both the producers & the consumers. The price of a product helps the consumers to know how important the available resources are for other consumers & the consumer has to keep in mind the interest of others while deciding whether to consume a particular good or not (incentive). If a consumer wants to consume something that is important for others too, then he has to give up something equally important in return.