SHADOW PRICE : The value of the contributions which a marginal change in the availability of a

commodity or a factor of production makes to a country’s basic socioeconomic objectives.

Shadow Price depends on:

 The fundamental objectives of the country.

 The physical constraints on resources.

Change in any if these will cause changes in the estimated shadow prices.

SHADOW PRICES AND ACCOUNTING PRICES

Accounting prices are shadow prices that satisfy accounting standard of administrative
feasibility.
A good can have numerous shadow prices when it is priced strictly on marginal cost basis as it
will vary with output and geographical distribution. Out these numerous shadow prices, the
ones laid down to be used are the accounting prices.

Reasons for Shadow Pricing

Market prices are defective in some situations in measuring the true social benefit or cost. Below are
situations that call for the use of shadow prices:

 Existence of monopolistic element

 Presence of taxes and subsidies (Govt. intervention)
 Existence of externalities
 Anticipated changes in supply & demand conditions (this will lead to disequilibrium prices
that do not reflect true costs & benefits)
 Existence of increasing returns to scale
 Existence of public goods.

Methods of Estimating Shadow Prices

 Solving Maximization Problems by LPP
 Taking over price relationships in mkt of similar items in similar countries.
 Adjustment of mkt prices
(i) By eliminating effects of taxes & subsidies)
(ii) By calculating cost of factor inputs)
 Using International border prices for traded goods (Little –Mirlees Approach)