A free price system or free price mechanism (informally called the price system or the price mechanism) is an economic

system where prices are set by the interchange of supply and demand, with the resulting prices being understood as signals that are communicated between producers and consumers which serve to guide the production and distribution of resources. Through the free price system, supplies are rationed, income is distributed, and resources are allocated. A free price system contrasts with a controlled or fixed price system where prices are set by government, within a controlled market or planned economy.

Mechanics of a free price system

A diagram presenting the argument for free prices Rather than prices being set by the state, as in a command economy with a fixed price system, prices are determined in a decentralized fashion by trades that occur as a result of sellers' asking prices matching buyers' bid prices as a result of subjective value judgement in a market economy. Since resources of consumers are limited at any given time, consumers are relegated to satisfying wants in a descending hierarchy and bidding prices relative to the urgency of a variety of wants. This information on relative values is communicated, through price signals, to producers whose resources are also limited. In turn, relative prices for the productive services are established. The interchange of these two sets of prices establish market value, and serve to guide the rationing of resources, distributing income, and allocating resources. Those goods which command the highest prices (when summed among all individuals) provide an incentive for businesses to provide these goods in a corresponding descending hierarchy of priority.

However, the ordering of this hierarchy of wants is not constant. Consumer preferences change. When consumer preferences for a good increase, then bidding pressure raises the price for a particular good as it moves to a higher position in the hierarchy. As a result of higher prices for this good, more productive forces are applied to satisfying the demand driven by the opportunity for higher profits in satisfying this new consumer preference. In other words, the high price sends a price signal to producers. This causes producers to increase supply, either by the same firms increasing production or new businesses coming in to the market, which eventually lowers the price and the profit incentive to increase supplies. Hence, the now lower price provides a price signal to producers to decrease production and, as a result, a surplus is prevented. Since resources are scarce (including labor and capital), supplies of other goods will be diminished as the productive resources are taken from other areas of production to be applied toward increasing output of the good who has risen in the hierarchy of consumer preferences. Also, as resources become scarcer the price increases, which signals to consumers to reduce consumption thereby ensuring that the quantity demanded does not exceed the quantity supplied. It is in this way that the free price system persuades consumers to ration dwindling resources. Hence, supply and demand affects price while at the same time, price affects supply and demand. If prices remain high because increases in supply cannot keep pace with demand, then this also signals other business to provide substitute goods in order to take advantage of profit opportunities. Individual employments and incomes are also guided by the price system. Employment will move toward those goods and services that consumers value and away from those with declining importance to consumers as a result of changes in prices. The price mechanism performs three main functions: 1. Rationing - when there is a shortage of a good, the price increases (it is "bid up"), leaving only those with the willingness/ability to pay to purchase the product. This causes supply and demand to reach an equilibrium. 2. Signalling - to demonstrate where resources are required, via a change in demand. For example, the price of goods which are scarce will increase. This increase in price should provide an incentive for producers to increase production of the good (i.e. a "signal" to producers). 3. Transmission of preferences - consumers are able to alert producers to changes in wants and needs, so that the market provides the right amount of the right goods.

Advantages of the price mechanism

The great benefit of the price mechanism is the invisible hand of price described by Adam Smith. It is able to signal the cost of purchasing a good to the consumer and signal to the producer the revenue that they will receive from the good. The idea of consumer sovereignty - consumers have the power to determine what is bought and sold in the market.

The freedoms of choice, property and enterprise can only be fulfilled in a system with operation of the price mechanism. Prices are as low as possible and resources go to the most efficient use. The system operates without regulation.

Disadvantages of the price mechanism

Inequality of income and wealth Without government intervention, there will be under-provision of public and merit good Unemployment Inflation Wastage on advertising etc.

The alternative to using the price mechanism is a planned economy (such as those under communism). Specialisation is when a factor of production is devoted to a specific job. This applies to all factors of production - land, labour, capital and enterprise. By specialising and trading, countries can increase overall output.

Contents
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1 Absolute and comparative advantage 2 The Gains from Trade 3 Division of labour o 3.1 Advantages o 3.2 Disadvantages o 3.3 Limits to the division of labour 4 Also See 5 Comments

Absolute and comparative advantage

When a country can produce more of a product per unit resource than its rivals can, it has absolute advantage. The country can produce at a lower factor cost. More important, however, is Ricardo's idea of comparative advantage. The producer with the lowest opportunity cost of production for a particular product has comparative advantage. For example, Portugal can produce more wine and cloth than England per unit resource (it has absolute advantage in both). Compared with Portugal, England is bad at producing cloth, but terrible at producing wine. Therefore England should specialise in cloth and Portugal in wine, because the opportunity cost of Portugal producing extra cloth is greater than producing extra wine.

The Gains from Trade

The most important gain from trade is increased output. This can lead to increased living standards, greater variety of goods and spread of technology. Other gains include:

Economies of scale Political links may prevent wars Competition gives greater efficiency and reduces the power of the monopoly producer

Division of labour
Division of labour is a special type of specialisation. The production of a good is spilt into many tasks which can be undertaken by different people. There are three types of division of labour:
1. Specialisation of people in trades or professions (e.g. milkmen) 2. Specialisation by process (e.g. jam making) 3. Specialisation by area (e.g. Silicon Fen, Cambridge) Advantages 1. 2. 3. 4. 5. 6. Time saving Increase in output due to productivity gains from increased economic organisation Improvement in quality of goods because specialists can perform better Makes the best use of natural abilities Reduction in costs because people work faster Automation as the use of machinery takes over repetitive tasks

Disadvantages 1. Mental disadvantages on workers of low job satisfaction 2. Strikes and absenteeism 3. Immobility of labour Limits to the division of labour

Some trades, such as handmade craft trades, are not suitable for specialisation. Large scale sales are needed for division of labour Management may not be efficient

Advantages: (1) The market gives producers an incentive to produce goods that consumers want. (2) The market provides an incentive to acquire useful skills. (3) The price system encourages producers and consumers to conserve scarce resources. (4) Competition pushes businesses to be efficient: keeping costs down and production high. (5) The market system involves a high degree of economic freedom. Disadvantages:

(1) A private market economy may be quite unstable (unemployment, inflation, growth) (2) Business may simply satisfy the wants they have created through advertising. (3) Prices may give false or inadequate signals to producers and consumers (externalities, like pollution). (4) Markets just do not work in some areas (public goods, such as national defense). (5) Monopolistic industries may restrict output and drive up prices. (6) Market economies tend to produce a skewed distribution of income (large gap between the rich and the poor).

Image Credits Mark Morgan. In a wider sense, Money includes all mediums of exchanges like Gold, Silver, Copper, Paper, Cheques, and Bills of exchange, etc.

Definition of Money

According to Crowther, "Anything that is generally acceptable as a means of exchange and which at the same time acts as a measure and store of value." Thus, Anything is Money, which is generally acceptable as a medium of exchange, and at the same time it must act as a measure and a store of value. Anything implies a thing to be used as money need not be necessarily composed of any precious metal. The only necessary condition is that, it should be universally accepted by people as a medium of exchange.

Functions of Money

Money performs five important functions :1. Medium of exchange : Money acts as a medium of exchange as it's generally accepted. On the payment of money, purchase of goods and services can be made i.e. goods and services are exchanged for money. Money bifurcates buying and selling activities separately so it facilitates the exchange transactions. 2. Measure of value : Money is a common measure of value so it is possible to determine the rate of exchange between various goods and services purchased by the people. Exchange value of

commodity can be expressed in terms of money. For e.g. we can say that 10 metres of Cotton Cloth cost $220 dollars or Rs.10,000 rupees only. 3. Store of value : Money acts as a store of value. Money being generally acceptable and its value being more or less stable, it is ideal for use as a store of value. Being non-perishable and also comparatively stable in value, the value of other assets can be stored in the form of money. Property can be sold and its value can be held in money and converted into other assets as and when necessary. 4. Standard or Deferred payment : Money is also inevitably used as the unit in terms of which all future or deferred payments are stated. Future transactions can be carried on in terms of money. The loans, which are taken at present, can be repaid in money in the future. The value of the future payments is regulated by money. 5. Transfer of value : Value of any asset can be transferred from one person to another or to any institution or to any place by transferring money. The transfer of money can take place irrespective of places, time and circumstances. Transfer of purchasing power, which is necessary in commerce and other transactions, has become available because of money.

What are the Indirect Taxes ? Meaning

An indirect tax is one in which the burden can be shifted to others. The tax payer is not the tax bearer. The impact and incidence of indirect taxes are on different persons. An indirect tax is levied on and collected from a person who manages to pass it on to some other person or persons on whom the real burden of tax falls. For e.g. commodity taxes or sales tax, excise duty, custom duties, etc. are indirect taxes.

Image Credits Scott Snider.

Hicks classifies direct & indirect taxes on the basis of administrative arrangements. In case of direct tax-there is a direct relationship between the taxpayer and the revenue authorities. A tax collecting agency directly collects the tax from the taxpayers, whereas in case of indirect taxes there is no direct relationship between the taxpayers and the revenue authorities. They are collected through traders and manufacturers.

Over the years the share of indirect tax has declined in India due to reduction in the rates of indirect taxes.

Advantages / Merits of Indirect Taxes

The merits of indirect taxes are briefly explained as follows :-

1. Convenient

Indirect taxes are imposed on production, sale and movements of goods and services. These are imposed on manufacturers, sellers and traders, but their burden may be shifted to consumers of goods and services who are the final taxpayers. Such taxes, in the form of higher prices, are paid only on purchase of a commodity or the enjoyment of a service. So taxpayers do not feel the burden of these taxes. Besides, money burden of indirect taxes is not completely felt since the tax amount is actually hidden in the price of the commodity bought. They are also convenient because generally they are paid in small amounts and at intervals and are not in one lump sum. They are convenient from the point of view of the government also, since the tax amount is collected generally as a lump sum from manufacturers or traders.

2. Difficult to evade

Indirect taxes have in built safeguards against tax evasion. The indirect taxes are paid by customers, and the sellers have to collect it and remit it to the Government. In the case of many products, the selling price is inclusive of indirect taxes. Therefore, the customer has no option to evade the indirect taxes.

3. Wide Coverage

Unlike direct taxes, the indirect taxes have a wide coverage. Majority of the products or services are subject to indirect taxes. The consumers or users of such products and services have to pay them.

4. Elastic

Some of the indirect taxes are elastic in nature. When government feels it necessary to increase its revenues, it increases these taxes. In times of prosperity indirect taxes produce huge revenues to the government.

5. Universality

Indirect taxes are paid by all classes of people and so they are broad based. Poor people may be out of the net of the income tax, but they pay indirect taxes while buying goods.

6. Influence on Pattern of Production

By imposing taxes on certain commodities or sectors, the government can achieve better allocation of resources. For e.g. By Imposing taxes on luxury goods and making them more expensive, government can divert resources from these sectors to sector producing necessary goods.

7. May not affect motivation to work and save

The indirect taxes may not affect the motivation to work and to save. Since, most of the indirect taxes are not progressive in nature, individuals may not mind to pay them. In other words, indirect taxes are generally regressive in nature. Therefore, individuals would not be demotivated to work and to save, which may increase investment.

8. Social Welfare

The indirect taxes promote social welfare. The amount collected by way of taxes is utilized by the government for social welfare activities, including education, health and family welfare. Secondly, very high taxes are imposed on the consumption of harmful products such as alcoholic products, tobacco products, and such other products. So it is not only to check their consumption but also enables the state to collect substantial revenue in this manner.

9. Flexibility and Buoyancy

The indirect taxes are more flexible and buoyant. Flexibility is the ability of the tax system to generate proportionately higher tax revenue with a change in tax base, and buoyancy is a wider concept, as it involves the ability of the tax system to generate proportionately higher tax revenue with a change in tax base, as well as tax rates.

Disadvantages / Demerits of Indirect Taxes

Although indirect taxes have become quite popular in both developed & Under developed countries alike, they suffer from various demerits, of which the following are important.

1. High Cost of Collection

Indirect tax fails to satisfy the principle of economy. The government has to set up elaborate machinery to administer indirect taxes. Therefore, cost of tax collection per unit of revenue raised is generally higher in the case of most of the indirect taxes.

2. Increase income inequalities

Generally, the indirect taxes are regressive in nature. The rich and the poor have to pay the same rate of indirect taxes on certain commodities of mass consumption. This may further increase income disparities among the rich and the poor.

3. Affects Consumption

Indirect taxes affects consumption of certain products. For instance, a high rate of duty on certain products such as consumer durables may restrict the use of such products. Consumers belonging to the middle class group may delay their purchases, or they may not buy at all. The reduction in consumption affects the investment and production activities, which in turn hampers economic growth.

4. Lack of Social Consciousness

Indirect taxes do not create any social consciousness as the taxpayers do not feel the burden of the taxes they pay.

5. Uncertainty

Indirect taxes are often rather uncertain. Taxes on commodities with elastic demand are particularly uncertain, since quantity demanded will greatly affect as prices go up due to the imposition of tax. In fact a higher rate of tax on a particular commodity may not bring in more revenue.

6. Inflationary

The indirect taxes are inflationary in nature. The tax charged on goods and services increase their prices. Therefore, to reduce inflationary pressure, the government may reduce the tax rates, especially, on essential items.

7. Possibility of tax evasion

There is a possibility of evasion of indirect taxes as some customers may not pay indirect taxes with the support of sellers. For instance, individuals may purchase items without a bill, and therefore, may not pay Sales tax or VAT (Value Added Tax), or may obtain the services without a bill, and therefore, may evade the service tax.

Conclusion

Elaborate analysis of merits and demerits of direct and indirect taxes makes it clear that whereas the direct taxes are generally progressive, and the nature of most indirect taxes is regressive. The scope of raising revenue through direct taxation is however limited and there is no escape from indirect taxation in spite of attendant problems. There is common agreement amongst economists that direct & indirect taxes are complementary and therefore in any rational tax structure both types of taxes must find a place.

The price mechanism is an economic concept that refers to the way that the price of a product is dependent upon the supply and demand for that product. First postulated by the economist Adam Smith, the concept relies on the workings of a free market system for its existence. Just as the price of a product will react to changes in supply and demand, so too will supply and demand respond to a change in price. Thus, the price mechanism helps to achieve a kind of balance between all of the elements in an economy. One of the main characteristics of a free market economy is how the decisions made by millions upon millions of consumers will reflect upon the way that goods are produced and those goods are priced. None of those seemingly disparate elements occur in a vacuum. Instead, they all depend upon each other and react to movements up and down the curve of supply and demand. Thus, the price mechanism reflects the action and reaction of the entire free market. For example, imagine that there is a sudden demand for light bulbs among the members of society. As the demand increases, the makers of the light bulbs will be able to raise the price of

the light bulbs to reflect that demand. In turn, the company that makes the light bulbs will devote more of its production efforts to light bulbs, thus increasing the supply to meet the demand.

With this example, the price mechanism has resulted in the initial rise of prices for the light bulbs. Since the initial demand for the light bulbs has been sated, and the increased production has resulted in more light bulbs being produced, the mechanism begins to shift back the other way. The price increase and the increased supply will result in less demand for the light bulbs. Once that occurs, the prices will drop back down, the companies will once again decrease their efforts to produce the light bulbs, and the cycle will revert back to somewhere near the original starting point. If demand for a certain product rises in inverse proportion to the supply, the price mechanism acts as a sort of rationing agent for that product. The price will rise to keep demand low until supply levels can catch up. Consequently, the prices can come back down again.

What is Perfect Competition ? Meaning

Perfect Competition is a market structure where there is a perfect degree of competition and single price prevails.

The concept of Perfect Competition was introduced by Dr. Alfred Marshall.

Image Credits Welker's Wikinomics.

Nothing is 100% perfect in this world. So, this states that perfect competition is only a theoretical possibility and it does not exist in reality.

Main Features of Perfect Competition

The following are the characteristics or main features of perfect competition :-

1. Many Sellers

In this market, there are many sellers who form total of market supply. Individually, seller is a firm and collectively, it is an industry. In perfect competition, price of commodity is decided by market forces of demand and supply. i.e. by buyers and sellers collectively. Here, no individual seller is in a position to change the price by controlling supply. Because individual seller's individual supply is a very small part of total supply. So, if that seller alone raises the price, his product will become costlier than other and automatically, he will be out of market. Hence, that seller has to accept the price which is decided by market forces of demand and supply. This ensures single price in the market and in this way, seller becomes price taker and not price maker.

2. Many Buyers

Individual buyer cannot control the price by changing or controlling the demand. Because individual buyer's individual demand is a very small part of total demand or market demand. Every buyer has to accept the price decided by market forces of demand and supply. In this way, all buyers are price takers and not price makers. This also ensures existence of single price in market.

3. Homogenous Product

In this case, all sellers produce homogeneous i.e. perfectly identical products. All products are perfectly same in terms of size, shape, taste, colour, ingredients, quality, trade marks etc. This ensures the existence of single price in the market.

4. Zero Advertisement Cost

Since all products are identical in features like quality, taste, design etc., there is no scope for product differentiation. So advertisement cost is nil.

5. Free Entry and Exit

There are no restrictions on entry and exit of firms. This feature ensures existence of normal profit in perfect competition. When profit is more, new firms enter the market and this leads to competition. Entry of new firms competing with each other results into increase in supply and fall in price. So, this reduces profit from abnormal to normal level. When profit is low (below normal level), some firms may exit the market. This leads to fall in supply. So remaining firms raise their prices and their profits go up. So again this ensures normal level of profit.

6. Perfect Knowledge

On the front of both, buyers and sellers, perfect knowledge regarding market and pricing conditions is expected. So, no buyer will pay price higher than market price and no seller will charge lower price than market price.

7. Perfect Mobility of Factors

This feature is essential to keep supply at par with demand. If all factors are easily mobile (moveable) from one line of production to another, then it becomes easy to adjust supply as per demand. Whenever demand is more additional factors should be moved into industry to increase supply and vice versa. In this way, with the help of stable demand and supply, we can maintain single price in the Market.

8. No Government Intervention

Since market has been controlled by the forces of demand and supply, there is no government intervention in the form of taxes, subsidies, licensing policy, control over the supply of raw materials, etc.

9. No Transport Cost

It is assumed that buyers and sellers are close to market, so there is no transport cost. This ensures existence of single price in market.

What is Monopolistic Competition ? Its Meaning

Pure monopoly and perfect competition are two extreme cases of market structure. In reality, there are markets having large number of producers competing with each other in order to sell their product in the market. Thus, there is monopoly on one hand and perfect competition on other hand. Such a mixture of monopoly and perfect competition is called as monopolistic competition. It is a case of imperfect competition. Monopolistic competition has been introduced by American economist Prof. Edward Chamberlin, in his book 'Theory of Monopolistic Competition' published in 1933.

Features of Monopolistic Competition

The following are the features or characteristics of monopolistic competition :-

1. Large Number of Sellers

There are large number of sellers producing differentiated products. So, competition among them is very keen. Since number of sellers is large, each seller produces a very small part of market supply. So no seller is in a position to control price of product. Every firm is limited in its size.

2. Product Differentiation

It is one of the most important features of monopolistic competition. In perfect competition, products are homogeneous in nature. On the contrary, here, every producer tries to keep his product dissimilar than his rival's product in order to maintain his separate identity. This boosts up the competition in market. So, every firm acquires some monopoly power.

3. Freedom of Entry and Exit

This feature leads to stiff competition in market. Free entry into the market enables new firms to come with close substitutes. Free entry or exit maintains normal profit in the market for a longer span of time.

4. Selling Cost

It is a unique feature of monopolistic competition. In such type of market, due to product differentiation, every firm has to incur some additional expenditure in the form of selling cost. This cost includes sales promotion expenses, advertisement expenses, salaries of marketing staff, etc. But on account of homogeneous product in perfect competition and zero competition in monopoly, selling cost does not exist there.

5. Absence of Interdependence

Large numbers of firms are different in their size. Each firm has its own production and marketing policy. So no firm is influenced by other firm. All are independent.

6. Two Dimensional Competition

Monopolistic competition has two types of competition aspects viz. i. ii. Price competition i.e. firms compete with each other on the basis of price. Non price competition i.e. firms compete on the basis of brand, product quality advertisement.

7. Concept of Group

In place of Marshallian concept of industry, Chamberlin introduced the concept of Group under monopolistic competition. An industry means a number of firms producing identical product. A group means a number of firms producing differentiated products which are closely related.

8. Falling Demand Curve

In monopolistic competition, a firm is facing downward sloping demand curve i.e. elastic demand curve. It means one can sell more at lower price and vice versa.

What is Stock Exchange? Meaning

Stock Exchange (also called Stock Market or Share Market) is one important constituent of capital market. Stock Exchange is an organized market for the purchase and sale of industrial and financial security. It is convenient place where trading in securities is conducted in systematic manner i.e. as per certain rules and regulations. It performs various functions and offers useful services to investors and borrowing companies. It is an investment intermediary and facilitates economic and industrial development of a country.

Image Credits Niyantha Stock exchange is an organized market for buying and selling corporate and other securities. Here, securities are purchased and sold out as per certain well-defined rules and regulations. It provides a convenient and secured mechanism or platform for transactions in different securities. Such securities include shares and debentures issued by public companies which are duly listed at the stock exchange, and bonds and debentures issued by government, public corporations and municipal and port trust bodies. Stock exchanges are indispensable for the smooth and orderly functioning of corporate sector in a free market economy. A stock exchange need not be treated as a place for speculation or a gambling den. It should act as a place for safe and profitable investment, for this, effective control on the working of stock exchange is necessary. This will avoid misuse of this platform for excessive speculation, scams and other undesirable and anti-social activities. London stock exchange (LSE) is the oldest stock exchange in the world. While Bombay stock exchange (BSE) is the oldest in India. Similar Stock exchanges exist and operate in large majority of countries of the world.

Definitions of Stock Exchange

According to Husband and Dockerary,

"Stock exchanges are privately organized markets which are used to facilitate trading in securities." The Indian Securities Contracts (Regulation) Act of 1956, defines Stock Exchange as, "An association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities."

Features of Stock Exchange

Characteristics or features of stock exchange are:1. Market for securities : Stock exchange is a market, where securities of corporate bodies, government and semi-government bodies are bought and sold. 2. Deals in second hand securities : It deals with shares, debentures bonds and such securities already issued by the companies. In short it deals with existing or second hand securities and hence it is called secondary market. 3. Regulates trade in securities : Stock exchange does not buy or sell any securities on its own account. It merely provides the necessary infrastructure and facilities for trade in securities to its members and brokers who trade in securities. It regulates the trade activities so as to ensure free and fair trade 4. Allows dealings only in listed securities : In fact, stock exchanges maintain an official list of securities that could be purchased and sold on its floor. Securities which do not figure in the official list of stock exchange are called unlisted securities. Such unlisted securities cannot be traded in the stock exchange. 5. Transactions effected only through members : All the transactions in securities at the stock exchange are effected only through its authorised brokers and members. Outsiders or direct investors are not allowed to enter in the trading circles of the stock exchange. Investors have to buy or sell the securities at the stock exchange through the authorised brokers only. 6. Association of persons : A stock exchange is an association of persons or body of individuals which may be registered or unregistered. 7. Recognition from Central Government : Stock exchange is an organised market. It requires recognition from the Central Government. 8. Working as per rules : Buying and selling transactions in securities at the stock exchange are governed by the rules and regulations of stock exchange as well as SEBI Guidelines. No deviation from the rules and guidelines is allowed in any case. 9. Specific location : Stock exchange is a particular market place where authorised brokers come together daily (i.e. on working days) on the floor of market called trading circles and conduct trading activities. The prices of different securities traded are shown on electronic boards. After the working hours market is closed. All the working of stock exchanges is conducted and controlled through computers and electronic system.

10. Financial Barometers : Stock exchanges are the financial barometers and development indicators of national economy of the country. Industrial growth and stability is reflected in the index of stock exchange. 11. 1. Money as a Medium of Exchange: The function of money as a medium of exchange solves all the difficulties of barter system. There is no necessity for a double coincidence of wants in the money economy. The man with cow who wants to purchase cloth need not seek a cloth seller who wants a cow. He can sell his cow in the market for money and then purchase cloth with the money obtained. 2. Money as Measure of Value: In money economy values of all commodities are expressed in terms of money. Money is like the yard stick of cloth merchant, as yard-stick measures all varieties of cloth, money measures the value of all varieties goods. This function of money makes transactions easy and also fair 3. Standard of Deferred Payment: In a money economy the contracts are made for future payments terms of money instead of goods and promise to repay the loan in money. In this way money is the standard of deferred payments. This function stimulates all kinds of economic activities wjtich depend on borrowed money. 4. Money as a Store of Value: Goods cannot be stored because they are perishable. People receive their incomes in money form and keep their savings in money form in banks.In this way, money is used to store value of commodities. 5. The essential or primary functions of money are: a) To serve as medium of exchange. b) To serve as a measure of value. The later two functions are of secondary importance because they; derived functions. In modern economy, money plays a very important role. Its disappearance would cause disappearance of the economy itself.

Functions of Money
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Functions of Money
We can classify functions of money into three groups. They are: 1. Primary Function 2. Secondary Function and 3. Contingent Functions There are two primary function of Money they are: 1. Medium of exchange 2. Measure of value.

Primary functions of Money

Money as a Medium of Exchange: The function of money as a common medium of exchange facilitate the activity of buying and selling of goods and services. This function effectively solve the problems of a barter system. It is the most important and unique function of money which separates it from near-money assets. Money splits exchange into two parts. Sale and Purchase. Money as a measure of value: Money act as a instrument for measuring goods and services in terms of their money value. In the absence of money, it would be tedious to measure the value of goods and services for the purpose of exchange. Thousands of goods are available in the market. You can imagine how difficult it is to exchange these goods if there is no common medium to value these goods and services. One person who is offering his product to different people should keep thousands of values for his one product to effectively do his business. Money removes this problem by acting as a common medium. Due to the introduction of money, a trader should keep only one value for his each goods and services. Also it is to be noted that different goods are measured in different physical units like Litter, Kilogram, meter etc. Comparison of value of goods which has different physical units also possible if you know the money value of each goods. Comparison of goods in different region or time is possible through knowing the money value of the goods. The use of money price also help us in estimating national income by adding up values of a wide variety of goods and services which are measured in different physical units. Money as a measure of value can serve satisfactorily only when its own value (i.e. purchasing power) remains stable over time. Continuous rise in general level of prices all over the world has made money a poor measure of value.

Secondary Functions of Money

Secondary functions are: 1. Money as a standard of deferred payments 2. Money as a store of value 3. Money as a means of transferring purchasing power Let us looking into it in detail Money as a standard of deferred payments: Money facilitates not only the current transactions of goods and services but also their credit transactions. It facilitates credit transactions when goods are exchanged against future payments. Now a days deferred payment is become our part of our life as loan installments, pension, insurance premium etc are paid as deferred payments. Money could be an effective standard of deferred payment. For that purpose the value of money should be stable. If prices increase or decrease sharply, resulting in large fluctuations in the value of money, it would make money a poor standard of deferred payments. Money as a store of Value: We can store or hold a part of our present earnings in the form of money to be spent in future. Money represents generalized purchasing power and is a perfectly liquid asst as well. It is stable in value and useful in purchasing goods and services to satisfy human wants in a future time. Also we can store it for a longer period and need less space than

other goods. So it is convenient to accumulate wealth in the form of money which can be converted in to any asset at any time. Money serve as a bridge from the present to the future as money saved today can shift our purchasing power from the present to the future. Money as a means of transferring purchasing power: Money is the most convenient form in which value can be transferred from one person to another and also one place to another. The reason is that it is light weight, high value and less space consuming as compared to other goods. Also everyone readily accept money irrespective of place. For example, transferring thousands of kilograms of food grains would be time consuming, expensive and incur a lot of efforts and wastage. On the other hand transferring value of that much food grain in the form or money is less expensive and easy by a cheque or a bank draft. So money act as a means of transferring purchasing power.

Contingent Functions of Money

Contingent Functions 1. Distribution of National Income 2. Basis of credit system 3. Maximization of utility and profits 4. Money imparts liquidity and uniformity to assets Distribution of National Income: In the modern world people join together to run a business organization. Many people contribute their money, efforts, skills and space etc. When that business organization make profits, it should be divided as per the proportion of efforts or skills or money put in by all those who are involved. Money helps in the distribution of national income among the people who have contributed in its production. This income is divided or distributed in the form of rent, wages, salary, interest, renumeration etc. It is very difficult to determine and and remunerate those who contributed machine, property or materials. This problem can be easily overcome by determining the money value of such properties and distribute income proportionate to their contribution. So money helps in the distribution of national output among the people. Basis of Credit System: The present day money (Coins, currency notes, cheques, bank drafts etc) is a promise to pay. The modern economy is based on promise to pay. One of the area of function of bank is to receive money from depositors and lend it to those who are in need for running business or purchasing goods. Banks charge a fixed or variable rate of interest for their service. Depositors also get a portion of interest for their deposits. So money can serve as a basis of credit system. Maximization of utility and profits: If a farmer who does farming make one or two types of crops in bulk quantity. If he sell it for cash, he can use that money for satisfying his many of the needs. Keeping food grains limits his utility. On the other hand when he turns it into cash i.e. money, his scope of utility increase. Likewise producers of goods can calculate the cost of production in the value of money and decide a selling price which is profitable. In this way they can maximize their profits. So another use of money is that maximization of utility as well as

profits. Money imparts liquidity and uniformity to assets: Money is convenient form for holding the wealth. As money can buy any asset at any time. As well as any assets can be converted in to money. So money is the most liquid form of asset. Another function of money is it can calculate the wealth of the person by calculating the value of his property and things that are in his possession in the form of money value. Total wealth of a person or a country can be ascertained by calculating the money value of all assets. So the another function of money is that it imparts liquidity and uniformity to assets.

TYPES OF DEMAND
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There are four types of demand namely Competitive Demand, Joint or Complementary Demand, Composite Demand and Derived Demand. Demand is the amount of a product buyers are willing and able to purchase at a given price over a particular period of time. a. Competitive Demand Commodities are substitutes if one can be used in place of the other. Substitute goods serve the same purpose and therefore compete for the consumers income. They are said to have competitive demand because of the fact that they compete for the consumers income. Examples of substitute goods are Milo and bournvita, butter and margarine and others. A change in the price of one affects the demand for the other. If for instance there is an increase in the price of butter, demand for margarine will increase which will ultimately increase the price of margarine, provided the supply of margarine does not change. On the other hand a decrease in the price of butter will lead to a decrease in the demand for margarine, and hence a fall in its price, given the supply. b. Joint or Complementary Demand Two or more goods are said to be jointly demanded when they must be consumed together to provided a given level of satisfaction. Some examples are cars and fuel, compact disc players and CD. There are perfect complementary goods and imperfect or poor complementary goods. For perfect complementary goods, the consumer practically cannot do without the other. An example is cars and fuel. On the other hand, for imperfect complementary goods, a consumer can do without the other, so long as a substitute is obtained. For complementary demand, a change in the price of one good affects the demand for the other. If there should be an increase in the price of compact disc players, there will be a decrease in the demand for discs, other things being equal. c. Derived Demand

When the demand for a commodity is derived from the demand for the final commodity, that commodity is said to have derived demand. Wood may be demanded for the purpose of manufacturing furniture and not for its own sake. Here, the demand for wood is derived from the demand for furniture. Demand for wood is therefore a derived demand. Factors of production such as land, labor, and capital have derived demand. This is because an increase in the demand for a commodity will result in an increase in the factors of production used in producing the goods. The price of the factors of production will increase, other things being equal. d. Composite Demand Composite demand applies to commodities which have several uses or are demanded for several and different purposes. Wood as mentioned in the example above is used for furniture tables, chairs, beds, windows, doors and others. A change in demand for one of them will affect all others. If there is an increase in demand for table this will result in higher prices being paid for wood. The high price for wood will increase the cost of production of chairs, bed, windows and doors and any other thing for which wood is used in manufacturing John Christie Adam Kizer Rabina Sherchan Cross-Price Elasticity is the measure of the responsiveness of the demand on the product under investigation compared to change in the price of a related good. Cross-price elasticity can be measured by the percentage change in the quantity demanded of one good divided by the percentage change in the price of a related good (Baye, 2006). The equation is Cross-price elasticity = (%Q)/(%P) Examples An example that can demonstrate this principle is the demand of SUV vehicles. When the price of gasoline increases, the demand for SUV decreases. This shows that the two products are complements. The amount that the demand for SUV decreases in relation to the gasoline increases is the measure of the Cross-Price Elasticity. If goods are complements, like in the above example, the cross-price elasticity of demand will be less than zero. The negative cross-price elasticity in simple terms, signifies that there is inverse relationship between price of gasoline and demand for SUV. As one increases the other decreases and vice- versa. A second example of cross-price elasticity can be seen between Nike and Adidas footwear. If the cross-price elasticity between these two is 2, 5% increase in the price of Nike will increase the demand for Adidas by 10%. When we see there is a direct relationship between the price of a good and the quantity demanded for the related good, they are substitue goods. Thus, for substitue goods, we have cross-price elasticity always greater than zero.

A third example of cross-price elasticity is between Coke and Pepsi. If the price of Coke increases by 10%, then the demand for Pepsi will increase by 20%. This results in a cross price elasticity between the two of 2. Like the example above, these two would be substitues since the cross-price elasticity is greater than zero. Fourth example is for breakfast cereals manufactured by Wild Oats and General Mills. These are substitute goods as an increase in the price of one good will lead to an increase in demand for the rival product. Cross price elasticity here will be positive. Below diagrams can help us understand the cross-price elasticity better.

Real world examples of Cross Price Elasticity: Product Under Investigation Comparison Product Price Elasticity US Domestic Tuna Imported Tuna 0.45 US Domestic Tuna Bread -0.33 US Domestic Tuna Ground Meat 0.3 Beer Wine 0.2 Beer Soft Drinks 0.3 Transit Automobiles 0.85 Transportation Recreation -0.05 Food Recreation 0.15 Clothing Food -0.18 Questions 1. Complementary goods have: a) The same elasticities of demand b) A positive cross-price elasticity of demand c) A negative cross-price elasticity of demand d) None of the above

The answer is C. When goods are complements the cross-price elasticity will be less than zero. 2. If tea and coffee are substitute goods, then the cross-price elasticity will be: a) Positive b) Negative c) Equal to zero d) None of the above The answer is A. If two goods are substitutes then the cross-price elasticity will be greater than zero. For example if the price of coffee rises then the demand for tea will rise as consumers substitue it for coffee. 3. If the price of a GM cars fall by 8% and during the same time period the demand for a Ford car decreases by 2%. The cross-price elasticity of the demand for Ford cars is: a) 0.5 b) 2.0 c) -0.25 d) 0.25 The answer is D. For cross-price elasticity it is the change in demand divided by the change in price (-2/-8). Also, the goods are substitues since the cross-price elasticity is greater than zero. 4) If the cross price elasticity between ketchup and mustard is 4, a 10% increase in the price of mustard will lead to a: a) 40% drop in the quantity demanded of ketchup b) 40% drop in the quantitiy demanded of mustard c) 40% increase in the quantitiy demanded of ketchup d) 40% increase in the quantity demanded of mustard The correct answer is C. The cross-price elasticity is equal to the change in demand divided by the change in price. Since we know the cross-price elasticity equals 4 and price increases by 10% for mustard we can solve for the demand of ketchup. The equation would be 4=(X/10), and if we solve for X, which is the demand for ketchup, it would be 40%. Since the 40% is positive that means that there is an increase in the quantity demanded. 5) If the price of basketball tickets increases by 10%, the demand for hokey tickets increases by 20%. What is the the cross price elasticity of demand for hockey tickets? a) 0.5 b) 2.0

c) -0.5 d) -2.0 The answer is C. For cross-price elasticity it is the change in demand divided by the change in price (20/10). Also, hockey tickets are a substitue for basketball tickets since the cross-price elasticity is greater than zero. 6) If computers and computer software are complementary goods. What should happen to the demand for computers if computer software prices increase? a) Increase b) Decrease c) Remain The Same The answer is B. Since the two goods are complements, and increase in the price of software will lead to a decrease in the demand for computers. 7) The equation for Cross-price elasticity is a) (%Q)/(%P) b) (%P)/(%Q) c) P/Q d) Q/P The answer is A. Please refer to the first paragraph of this page. 8) For substitue goods, we have cross-price elasticity a) Always less than zero b) Always greater than zero c) Always equal to zero d) None of the above The answer is B. There is a direct relationship between the price of a good and the quantity demanded for the related good when they are substitue goods. Increase in the price of one good will lead to an increase in demand for the other and thus cross price elasticity will always be positive. 9) Cross-price elasticity equals to zero for a) Complementary goods b) Substitute goods c) Unrelated goods d) None of the above

The answer is C. When there is no relationship between two products, the cross price elasticity of demand is zero. References: