What Are Price Policies?

Abstract

Prices fulfil three functions: they are signals, incentives, and instruments for the allocation of resources and incomes. Signals are indicators of shortages or gluts, for example, without necessarily carrying with them any incentives to follow them. Incentives are promises of profits for following the signals or threats of losses for disobeying them. Instruments are any means used to achieve the objectives. In principle, these functions can be separated, so that, say, a high price of an item signals scarcity, but resources are not permitted to flow into greater production of that item because an indirect tax is interposed. Or shadow prices can be used for allocating resources, while no financial incentives encourage this. It is possible to imagine an economy in which all prices are zero, all goods are rationed, and all incentives are moral. In a free market economy, prices combine the three functions. The main purpose of price policies is to achieve objectives that, in their absence, would not be achieved.