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Price Theory: Meaning and Its Limitations | Micro Economics

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In this article we will discuss about Price Theory. After reading this article you will learn about: 1. Meaning of Price Theory 2. Limitations of Price Theory.

Meaning of Price Theory:

Every individual is interested in prices; and rightly so. Everyone whether he is a consumer or a producer is affected by rise or fall in prices. A consumer is anxious to find out whether the goods he wants to buy have become cheaper or dearer. Similarly, producer is interested in whether the prices of the products he produces and the inputs he uses, have gone up or down.

Oscar Wilde once remarked – “An economist is someone who knows the price of everything and the value of nothing.” This observation may not be true at all. But economists right from Adam Smith, Marx, Jevons and Marshall to Joan Robinson, Chamberlin and Hicks have been engaged in explaining how prices are determined and why and when they are high or low. This is the Subject matter of price theory.

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Price theory, also known as microeconomics, is concerned with the economic behaviour or individual consumers, producers, and resource owners. It explains the production, allocation, consumption and pricing of goods and services.

Price theory, as defined by Prof. Leftwich, “is concerned with the flow of goods and services from business firms to consumers, the composition of the flow, and the evaluation or pricing of the component parts of the flow. It is concerned, too, with the flow of productive resources (or their services) from resource owners to business firms, with their evaluation, and with their allocation among alternative uses.”

Limitations of Price Theory:

Price theory has its limitations:

1. It simply provides a theoretical analysis of the working of the individual parts of the economy. But the operation of individual parts does not give a true picture of the working of the economy. Every economic unit is so complex and requires such minute description and analysis that price theory is unable to do justice.

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2. It only lays down guidelines based on a given data. Often the data are not reliable. It is based on estimation which may prove to be wrong.

3. Even the assumption of rationality on which decision-making is based to achieve the most efficient use of scarce resources is seldom observed by businessmen and consumers. Still, the assumption of rationality helps in economizing scarce resources with efficiency.

4. Price theory may not give a description of the real world since it is based on limited data and unrealistic assumptions but by concentrating on the most important data we get an insight into the working of the economy.

As put by Leftwich:

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“We may lose sight of individual trees but we gain more understanding and a better view of the forest as a whole.” Price theory is no doubt abstract but it should be judged for its truth and not for its realism.

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