Question

A) Explain the role of prices in allocating scarce resources in a market economy.

B) Discuss the view that that the use of maximum and minimum price controls only serve to distort markets and bring about a misallocation of resources.  

Answer 1

Ans

1 prices serve as main means of allocating resources. People pay more for the good which they like most. As a result prices of these goods are high relative to other goods. Higher goods give incentive to people to invest in these goods. As a resource more resources are allocated to such sectors. In this way prices allocate resources in a market economy. Whatever is produced is according to the utility and choices of people

2 Yes they serve to distort markets. Markets can function effecientlly only through self interest of individuals. Now when Govt regulates market it leads to misallocation of resources. E. G if price is set above equilbrium through minimum prices, industrialists produce more such goods.Hence more resources are diverted to these sectors which is against choice of people.Similarly maximum prices reduce resources diverted to such sectors which are brought under this control as prices are below equilbrium prices.