Chapter 5: PricesChapter 5: Prices

Section 1: The Price System

Section 1: The Price System

Price system guides producers and consumers

What is relationship between producers and consumers when setting prices? If a product is not bought, producers must do something…

Price system guides producers and consumers

What is relationship between producers and consumers when setting prices? If a product is not bought, producers must do something…

Benefits of the Price System Information: prices inform consumers of the

relative worth of the goods and services they purchase

Incentives: the law of supply and demand are reflected; what’s good for the consumer/producer

Choice: higher incentive to provide product, the greater the choice of products supplied

Efficiency: 1) determines how to most effectively use resources - high prices = use resources appropriately - low prices = stop using resources if consumers won’t buy; comparing prices allows consumer to find best deal (most efficient)

Flexibility: price system is able to deal with change; ex. A freeze destroys a large portion of the orange crop, price of oranges increases - this determines how orange supply will be distributed

Benefits of the Price System Information: prices inform consumers of the

relative worth of the goods and services they purchase

Incentives: the law of supply and demand are reflected; what’s good for the consumer/producer

Choice: higher incentive to provide product, the greater the choice of products supplied

Efficiency: 1) determines how to most effectively use resources - high prices = use resources appropriately - low prices = stop using resources if consumers won’t buy; comparing prices allows consumer to find best deal (most efficient)

Flexibility: price system is able to deal with change; ex. A freeze destroys a large portion of the orange crop, price of oranges increases - this determines how orange supply will be distributed

Limitations of the Price System - also known as market failures Externalities: side effects to production. Both

positive and negative - (neg.) pollution, (pos.) restaurants next to a factory benefit from lunch goers, yet do not assist production company. The price system fails to assess this efficiently.

Public Goods (goods consumed by all members of public, such as national defense, judicial system, law enforcement): some are unwilling to pay for these benefits, but still have them. The price system does not fairly distribute this cost.

Instability: severe weather, natural disasters, worker protests can swing prices with little notice. While the price system is flexible, it is also instable

Limitations of the Price System - also known as market failures Externalities: side effects to production. Both

positive and negative - (neg.) pollution, (pos.) restaurants next to a factory benefit from lunch goers, yet do not assist production company. The price system fails to assess this efficiently.

Public Goods (goods consumed by all members of public, such as national defense, judicial system, law enforcement): some are unwilling to pay for these benefits, but still have them. The price system does not fairly distribute this cost.

Instability: severe weather, natural disasters, worker protests can swing prices with little notice. While the price system is flexible, it is also instable

Section 2: Determining PricesSection 2: Determining Prices The goal of the price system is to reach

market equilibrium - when quantity supplied and quantity demanded for a product are equal at the same price. At this point the needs of both producers and consumers are satisfied and the forces of supply and demand are in balance.

See page 103 - point at which demand and supply meet on graph

Does this happen automatically? No way, trial and error is almost always necessary

The goal of the price system is to reach market equilibrium - when quantity supplied and quantity demanded for a product are equal at the same price. At this point the needs of both producers and consumers are satisfied and the forces of supply and demand are in balance.

See page 103 - point at which demand and supply meet on graph

Does this happen automatically? No way, trial and error is almost always necessary

Surpluses: exists when the quantity supplied exceeds the quantity demanded at the price offered

Shortages: exists when the quantity demanded exceeds the quantity supplied at the price offered

How do producers react? They either have to lower their price or raise the price…

In 2000 Sony’s new PlayStation2 was in high demand, however, some computer parts were in short supply. The PlayStation2s sold out in record time and people were willing to pay quadruple to price on eBay because of the shortage

Shifts in Equilibrium: what causes the shift? Consumer tastes, preferences, market size, income, prices of related goods, consumer expectations, government actions, technology, competition…

Surpluses: exists when the quantity supplied exceeds the quantity demanded at the price offered

Shortages: exists when the quantity demanded exceeds the quantity supplied at the price offered

How do producers react? They either have to lower their price or raise the price…

In 2000 Sony’s new PlayStation2 was in high demand, however, some computer parts were in short supply. The PlayStation2s sold out in record time and people were willing to pay quadruple to price on eBay because of the shortage

Shifts in Equilibrium: what causes the shift? Consumer tastes, preferences, market size, income, prices of related goods, consumer expectations, government actions, technology, competition…

Section 3: Managing PricesSection 3: Managing Prices Why might the government step in to

control or manipulate the price system? Price Ceiling: government regulation

that established maximum price for a particular good - ex. Rent control

Price Floors: government regulation that establishes a minimum level for prices - ex. Crops - corn. If there is a surplus of corn, there is a set price so that farmers can make money. Another example - minimum wage

Why might the government step in to control or manipulate the price system?

Price Ceiling: government regulation that established maximum price for a particular good - ex. Rent control

Price Floors: government regulation that establishes a minimum level for prices - ex. Crops - corn. If there is a surplus of corn, there is a set price so that farmers can make money. Another example - minimum wage

Consequences of Setting Prices Should there be floors and ceilings? If you have a ceiling on rent control, let’s

say $600 per month. That can (and probably will) result in a shortage. Why? Remember, law of supply explains that higher prices encourage increases in quantity quantity supplied, and lower prices encourage reductions in quantity supplied. Thus, if there is less profit available for the producer, they will supply less. At this point the equilibrium will not be met.

Consequences of Setting Prices Should there be floors and ceilings? If you have a ceiling on rent control, let’s

say $600 per month. That can (and probably will) result in a shortage. Why? Remember, law of supply explains that higher prices encourage increases in quantity quantity supplied, and lower prices encourage reductions in quantity supplied. Thus, if there is less profit available for the producer, they will supply less. At this point the equilibrium will not be met.

Rationing: product is distributed on the basis of policy decisions rather than on the basis of prices determined by supply and demand Usually occurs during wars and/or other crises

Also, college sports tickets - only a certain number of tickets available does not meet demand, tickets are rationed

Consequences - unfair - distributes unfairlyexpensive - government must determine how

much for each person, how to give outcreates black markets - exchanging goods

illegally, are these unfair?

Rationing: product is distributed on the basis of policy decisions rather than on the basis of prices determined by supply and demand Usually occurs during wars and/or other crises

Also, college sports tickets - only a certain number of tickets available does not meet demand, tickets are rationed

Consequences - unfair - distributes unfairlyexpensive - government must determine how

much for each person, how to give outcreates black markets - exchanging goods

illegally, are these unfair?