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Chris Phelps
Chris Phelps, CPA/CFP/PFS
Category: Finance
Satisfied Customers: 2710
Experience:  Certified Public Accountant for over 19 Years/Certified Financial Planner for over 10 Years
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Customer Question

How is the price system solve the 'how' problem of resource allocation?
Submitted: 11 years ago.
Category: Finance
Expert:  Chris Phelps replied 11 years ago.

The ability of a particular product or service to command a "price" determines the profit potential of that product or service.  The higher the profit potential the more resources that will get allocated to it to exploit the profit potential. 

This is essentially an arbitrage where the early providers of the product or service reap the majority of the profits.  As others see the excess profit potential they allocate resources to take advantage (i.e. competitors start entering the market).  Eventually, enough the additional competition lowers prices (and profit potential) to the point that the incentive to enter into the market is very low.

Our system basically allocates capital and resources to the things people value the highest (i.e. to those things people are willing to pay a premium for).