Which of the following best describes the role of prices in a market economy?

• A. Prices are set by the government to control production.
• B. Prices are determined solely by tradition and custom.
• C. Prices have no impact on consumer or producer decisions.
• D. Prices act as signals that help allocate resources efficiently.

Answer: (D)

Verified step by step guidance

1. Understand the concept of prices in a market economy: Prices are not arbitrarily set by the government or solely by tradition; instead, they emerge from the interaction of supply and demand.
2. Recognize that prices serve as signals: When prices rise or fall, they convey important information to both consumers and producers about the relative scarcity or abundance of goods and services.
3. Analyze how prices influence decisions: Higher prices typically encourage producers to supply more and consumers to buy less, while lower prices encourage the opposite behavior, leading to efficient allocation of resources.
4. Contrast the incorrect options: Government-set prices can lead to inefficiencies, and prices determined solely by tradition ignore market dynamics; prices having no impact contradicts basic economic principles.
5. Conclude that the best description is that prices act as signals that help allocate resources efficiently, guiding both production and consumption decisions in a market economy.