What, how much and for whom to produce.
Prices solve the problem of what to produce and in what quantities. There are unlimited wants but there is scarcity of productive resources. Consumers offer high prices for those goods they need most. Producers consequently produce such commodities, thereby getting larger profits. Consumers offer low prices for those goods, which are less important and producers react to this by supplying less of such goods. Prices guide the consumers and producers. If the price is high, the producers will be willing to supply more but the consumers will be buying less and vice versa. The consumer is sovereign, sets the price and producers manufacture those commodities, which the consumer wants. If the consumer wants less of a certain commodity, it follows that less of that commodity has to be produced.
Resources allocation. Resources are allocated in a free market economy by the forces of demand and supply. Resource allocation is determined by the price-profit mechanism. Resources will move away from economic activities where there are low prices and profits towards economic activities where prices and profits are high.
Method of production. Prices determine the technique to be used for
producing a certain commodity. Prices of factor services [wage, interest, rent, and profit] determine the technique to be adopted. These payments or rewards to factor services make up the cost of production. Each producer aims at using the most efficient productive technique - a technique that produces the greatest amount of a commodity with the minimum cost. The choice will depend on the relative prices of the factor services. The producer tends to use a technique, which uses more of a cheaper factor service other things remaining constant.
producing a certain commodity. Prices of factor services [wage, interest, rent, and profit] determine the technique to be adopted. These payments or rewards to factor services make up the cost of production. Each producer aims at using the most efficient productive technique - a technique that produces the greatest amount of a commodity with the minimum cost. The choice will depend on the relative prices of the factor services. The producer tends to use a technique, which uses more of a cheaper factor service other things remaining constant.
To determine the distribution of income. Prices determine the distribution of income. Owners of factor services sell their services for money and then spend that money to buy goods and services. Producers sell goods and services to consumers for money and consumers receive incomes as owners of factor services. Income flows from resource owners to producers and back to consumers. Prices play an important role in this flow. The income of an individual depends upon the amount of resources owned and their evaluation. People owning large quantities of resources, which are highly priced, have high incomes and vice versa.
To provide an incentive to growth. Prices are important means for economic growth. The impetus for improvement innovation and development comes through price mechanism. Higher prices and profits encourage large industrial concerns to spend huge sums of money on research. New and better techniques, which lead to more production, will be developed. If prices are low, there are no incentives to growth.