Price mechanism

In economics, a price mechanism is the manner in which the profits of goods or services affects the supply and demand of goods and services, principally by the price elasticity of demand. A price mechanism affects both buyer and seller who negotiate prices. A price mechanism, part of a market system, comprises various ways to match up buyers and sellers.

The price mechanism is an economic model where price plays a key role in directing the activities of producers, consumers, and resource suppliers. An example of a price mechanism uses announced bid and ask prices. Generally speaking, when two parties wish to engage in trade, the purchaser will announce a price he is willing to pay (the bid price) and the seller will announce a price he is willing to accept (the ask price).

The primary advantage of such a method is that conditions are laid out in advance, and transactions can proceed with no further permission or authorization from any participant. When any bid and ask pair are compatible, a transaction occurs, in most cases automatically.^[1]

Samuelson wrote that "the price mechanism, working through supply and demand in competitive markets, operates to (simultaneously) answer the three fundamental problems of economic organization in our mixed private enterprise system..."^[2] and establish an equilibrium system of prices and production.^[2] At competitive equilibrium, the value society places on a good is equivalent to the value of the resources given up to produce it (marginal benefit equals marginal cost). This ensures allocative efficiency: the additional value society places on another unit of the good is equal to what society must give up in resources to produce it.^[3]