5. To Provide an Incentive to Growth:Lastly, prices are an important factor in providing for economic growth. The impetus forimprovement, innovation and development comes through the price mechanism. Higherprices and profits encourage large industrial concerns to spend huge sums on research andexperimentation to improve and develop better techniques.The adaptation of the economic system to change in wants, resources and technologiestakes place through prices. If consumers want more of one commodity in preference tothe other the price of the former rises. Resources move to that industry. Profits alsoincrease. Larger profits lead to the adoption of superior technology which lowers costs.Larger profits and low costs attract new producers who provide new capital. All this leadsto capital formation. No doubt economic growth depends upon a number of other factors,yet prices play an important role in providing for economic growth with stability. This isexplained in figure 4.In this diagram, the economy is stagnant at points inside the production possibility curvePP. For its economic growth, it has to be moved on to point A of the productionpossibility curve PP whereby the economy produces larger quantities of consumer andcapital goods. This is possible through a higher rate of capital formation which consists ofreplacing existing capital goods with new and more productive ones by adopting moreefficient production techniques or through innovations.More growth leads to the outward shifting of the production possibility curve from PP toP1P1. Point C represents this situation where larger quantities of both consumer and
capital goods are produced in the economy. In this way, economic growth enables theeconomy to have more of both the goods through higher prices, profits and incomes.Thus the price mechanism, working through supply and demand in a free enterpriseeconomy acts as the principal organizing force. It determines what to produce and howmuch to produce. It determines the rewards of the factor services.It brings about an equitable distribution of income by causing resources to be allocated inright directions. It works to ration out the existing supplies of goods and services, utilizesthe economy’s resources fully and provides the means for economic growth.Limitations:The price mechanism does not operate freely. It acts under certain restraints placed by thegovernment in a free enterprise economy. Moreover, there are the “imperfections ofcompetition” which hinders the working of the price mechanism.Let us identify these factors as below:1. The government issues directives to producers to manufacture goods of different typesand in fixed quantities which are required to meet the social wants.
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- Fall '19