What Is The Practical Importance Of Shadow Prices?

Because of market imperfection and price distortions the resources are allocated suboptimal in the developing countries. Therefore, the project appraisal just on the basis of market prices looks meaningless. Moreover, during the plan period the prices may rise, leading to overestimations of costs and benefits. Therefore, for the sake of evaluation of projects the shadow prices are employed. The goods and the factors which are limited in supply should be assigned a higher shadow prices. While the goods and factors which are in abundance should be assigned a lower shadow price. All this means that shadow prices will give a better estimation of costs and benefits of the projects.

Shadow prices also become helpful in formulating public policies. On the basis of shadow prices the planners and plan executing agencies become aware of with the real prices of goods and factors. Therefore, they can devise and exercise fiscal and monetary policies in such a way that the difference in between market prices and shadow prices be minimized. In this way, the plan could effectively be implemented.

Shadow prices are also helpful in programming. The programming implies an effective allocation of resources to attain certain objectives. In case of UDCs the problems of demand and supply of goods, inflation and shortage of foreign exchange are commonly faced.

In calculating the financial value of externalities for cost benefit analysis