Download Supply and Demand: Notes 4: Role of Price

The Role of Prices in the Free
Market
Prices in the Free Market
• In the free market prices are a tool for
distributing
• They are nearly always the most
• Prices help move land, labor and capital
• Prices move finished goods into the
The Advantages of Prices
• Prices provide a language for buyers and
sellers
• Price as incentive:
– Buyers and sellers look at prices to
– Prices communicate to both buyers and sellers
– Producers respond not only to the demand, but also
to the
The Advantages of Prices
• Prices as signals
– High price of a good tells producers that if the
demand for a good at a
– Low price of a good tells producers that the good
is being overproduced
– High price of a good tells consumers to think
– Low price of a good tells consumers to buy
The Advantages of Prices
• Flexibility
– Prices are much more flexible than output levels
– Prices can easily be increased to solve a problem of excess
demand and they can be
• Supply shock a sudden
– Creates a problem of excess demand because suppliers
– Resolved by
– The people who have enough money remain in the market
at the new price and
A Wide Choice of Goods
• Prices give suppliers a way to allow
• Prices provide an easy way for you to
• Prices allow producers to target the audience
they want with the
• Black market a market
Efficient Resource Allocation
• All the advantages of a free market allow
• This means that land, labor, and capital will be
used for
• A market system, with its freely changing
prices, ensures that resources go to
• A price-based system ensures that resource
use will adjust to
Market Problems
• Problem 1 imperfect competition: can affect prices,
and higher prices can affect consumer decisions
– If only one producer is selling the good, this producer
• Problem 2 spillover costs: costs of production that
affect people
– Since producers do not have to pay spillover costs, their
total costs seem low, and they will produce more than
equilibrium quantity of a good.
 Problem 3 imperfect information: if you don’t have
enough information about a product,