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Most of the countries in the world basic economic problems are solved through price system or price mechanism. Millions of producers and consumers engage in voluntary trade, intending to improve their own economic situations and their actions are invisibly co-ordinated by a system of prices.

Price system is a mechanism of prices and price changes. Everything has a price which is the value of a commodity expressed in terms of money. Prices represent the terms on which people and firms voluntarily exchange different commodities.

In a free market company, prices are freely determined by demand and supply. A price is in equilibrium when demand equals supply. Price goes up when there is an increase in demand, supply remaining constant. Price goes down when there is an increase in supply, demand remaining constant.

Thus, prices serve as signals to producers and consumers. A rise in price informs the producers that more supply is needed, at the same time it instructs the consumers to substitute other goods. Means, price co-ordinates the decisions of the producers and consumers.

Here, it should be noted that price system as described above is an integral part of a free market economy that is called as capitalism. Because in a free market economy, government intervention in the working of price mechanism is as little as possible. Producers are free to produce any commodity, in any quantity and with any method they like. Consumers are free to spend their income on goods and services in any manner they like.

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