Classical economists claimed that in a capitalist economy price mechanism solves the central economic problems efficiently.
It ensures the efficient allocation of resources and maximum welfare of the society. The efficient working of price mechanism depends mainly on three things-(i) freedom of choice (ii) perfect competition and (iii) consumers sovereignty.
But in reality these conditions are non-existent. It is believed that uncontrolled price mechanism has failed to deliver the goods. There are certain inherent weaknesses of price mechanism.
Consumers’ sovereignty is a myth:
The growth of giant corporations, big businesses and monopolies has restricted the consumers’ sovereignty.
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These big corporations and monopolies themselves try to create wants by aggressive advertisement and propaganda.
Thus, the initiative in deciding what to produce comes not from the consumers but rather it comes from the big producing corporation.
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1. Market imperfections:
Existence of perfect competition is essential for the efficient working of price mechanism. But in real world we actually find monopolies and oligopolies.
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The extent to which competition declines, the price mechanism is weakened to work efficiently. Producers and resources suppliers will be less subject to the preferences of consumers.
These due to market imperfections price mechanism fail to allocate resources efficiently and in accordance with the wishes of consumers.
2. Economic inequalities:
Unsettered working of price mechanism generates economic inequalities in a capitalist economy. The economic inequalities in a capitalist economy have reduced the freedom of choice to a force.
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Therefore, in a free market economy only a handful of big capitalists decide what, how and for whom to produce.
3. Cyclical fluctuations:
Free working of market mechanism tends to generate economic instability and unemployment because there is lack of automatic adjustment in market mechanism.
4. Ignores external effect:
The purchase of goods may result in external costs or benefits to other members of the society.
Similarly, a producer may use resources in such a way as to cause cost or benefit to others. In other words, the uncontrolled pre-mechanism does not take into account the social costs.
5. Ignores the collective wants:
Self interest works like an invisible hand in free market economy. The private producers use the resources in such a way that they can earn maximum profits.
Production of collective consumption goods requires huge investment and generates less profit. Therefore, collective consumption cannot be supplies by the market mechanism.
Thus, due to the limitations of price system, the free market mechanism fails to perform the basic functions efficiently in a capitalist economy. Therefore, the various limitations of the price mechanism call for some sort of control and regulation of the price mechanism.