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Economic Survey
Mr. Rubin de Celis
Chapter 6.3 - The Role of Prices
Prices are a key element of equilibrium
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In a free market, prices are a tool for distributing goods and resources
Most efficient
Prices in the Free Market
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Prices help move capital, labor and resources into the hands of the producer
Advantages of price - Prices provide a language for both buyer and seller
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Prices as an incentive
o The laws of supply and demand describe how people and firms respond to changes in price
o Prices send a signal that tell consumer or producer how to adjust
o Prices tell the consumer whether the product is in short supply or readily available
o The Cabbage Patch dolls – price told producer that there now was a shortage with high demand
§ Producer immediately began producing more dolls at higher prices
§ Attracted other producers
Prices as signals
o Think of prices as a traffic light
o Green – demand is high and producer should produce more
§ New suppliers will join in
o Red light – low price means low demand
§ Good is being overproduced
§ This will tell producer that they could use existing resource to produce something else.
o for a consumer a low price is a green light to buy more of a good
§ a low price tells the consumer that the item carries a low opportunity cost
§ offers a good buying opportunity
o for a consumer high prices is a red light to stop buying more goods
Flexibility
o Prices can easily be increased to solve the problem of excess demand
o Prices can easily be decreased to solve the problem of excess supply
o A supply shock – a sudden shortage of a good
§ Gasoline or wheat are good examples
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Producer must ration or divide existing supply so that more can have it
o How to solve this problem
§ Increase supply can be time consuming – wheat
§ Rationing – dividing up goods and service using criteria other than price
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Expensive and can take along time
o Raising prices is the quickest way to resolve excess demand
§ A quick rise in price will reduce quantity demanded to the same level as quantity supplied
o Price system
§ Free market pricing attempt to distribute goods through millions of decisions made daily
§ Prices help goods flow through the economy without a central plan
A Wide Choice of Goods
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The benefits of a price driven economy is the diversity of foods and services consumers can buy
o Price allows consumer to choose among similar products
o Prices also allow producers to target the audience they want with the product
In a command economy, one organization decides what goods are produced and how much stores will charge
o To limit costs, a command economy will restrict production
o Consumers have far fewer choices
o The command attempted to distribute wealth evenly throughout their system
Rationing and Shortages
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o Goods in a command economy were inexpensive
o Consumers could not always find what they needed
§ Consumers had to wait years for apartments, or telephones
§ Make long lines for bread, meat, and poultry
§ Price controls were instituted
Rationing in the United States – only in times of desperate need
o WWII – rationing of metal, rubber, and food for the armed forces
o Shortages were created
o Government controlled the price and distribution of some goods and services
o Choices were limited
o Rationing was put into place because the government thought that food prices and housing prices were
going to be out of the reach of many
o Government wanted to guaranteed every American an equal share
The Black Market
o Government was unable to control the supply passing through the economy
o When people conduct business without regard for government controls on price or quantity
o Black markets allow consumers to pay more so they can buy a good when rationing makes it otherwise
unavailable
o Black markets in many countries is illegal and discouraged
Efficient Resource Allocation
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Efficient Resource Allocation
o Economic resources will be used efficiently
o A free market ensures that resources go to the uses that consumers value most important
o A price based system will adjust to the changing demands of the consumer
o Both consumer and producer seek the largest possible return
Price and the Profit Incentive
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Prediction affects consumer demand
o Demand will exceed supply
o Consumers bid up the price
o Home prices in Wisconsin
o Home prices in Evanston, Wilmette, Winnetka, Glencoe
§ Recognize the profit potential
§ Supplier will increase supply
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Homeowners are willing to sell their homes
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Flipping
o Landowners tend to use their scarce property in a most profitable manner
Wealth of Nations
o Suppliers do not supply consumer just for the heck of it
o The supplier knows that there is a profit to be made
o Finding out what people want and providing it
Market Problems
o Imperfect competition can affect prices
§ Higher prices can affect consumer decisions
§ When one producer supplies the market, higher prices will result
§ No competition
o Spillover costs
§ An externality that is created by production
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Air and water pollution
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Producer does not have to pay for spillover costs
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Their prices seem artificially low
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They will produce over the equilibrium price
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Any extra costs will be paid by the consumer
o Imperfect information can prevent a market from working smoothly
§ If buyer and seller do not have enough information to make an informed decision
Section 3 Assessment
1
How does a supply shock affect equilibrium price and quantity?
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How is rationing different from a price based market system?
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List three reasons why a price base system works more efficiently than central planning?
Price based system
Central planning
1) allows for flexibility in the marketplace between
consumer and supplier
1) Command economy answers the three economic question
2) allows for a larger selection of goods and services
2) Command economy is very inefficient at delivering goods
and services to the marketplace despite their lower prices.
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service.
Give two examples of situations in which prices gave you an incentive to purchase or not purchase a food or
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5. In your group, have each student bid for items from the following basket of goods and services: 10 pairs of movie
tickets; 20 fine restaurant dinners, 40 bagels, 5 pair of running shoes, and 30 hours of dog walking. - $50 play money
a)
What prices were bid for these goods?
b)
Why do you think some goods received higher bids than others?
c)
What do you think would happen to the bids if the number of items for sale doubled?