Study guide - short answer - Assignment Example

Download file to see previous pages... Prices play a significant role in influencing inflation/deflation and setting up demand and supply. There is minimal or no government intervention in free market economies. The forces of demand and supply determine how much should be produced and establish the income distribution curve. The price mechanism in a free market economy represents a cycle of real income from consumers to producers and back.
For example; if the government prints out money to pay war contractors, the prices of equipments used in war will increase. The money incomes of the war contractors and their employees will significantly increase. The increase in their spending power will induce them to consume more commodities. The sellers will be compelled to increase their prices to match the increased demand. The war contractors and employees will be willing to spend their money income to pay for the higher prices rather than do without the commodities. Increased money incomes mean that a dollar will have a lower subjective value.
Illustration: Let the war contractors and employees be, ‘W,’ and those who directly supply the commodities to them be, ‘X.’ Group X will increase its purchases from its wholesalers (Y). Group Y will have more income to purchase more commodities from the producers (Z). The cycle is continuous such that the increase in money incomes and prices covers the whole nation. When the cycle is complete, almost everyone will indicate higher incomes in terms of ...Download file to see next pagesRead More