PricesPrices

The Role of PricesThe Role of Prices

In a free market, prices are a tool for In a free market, prices are a tool for distributing goods and resources distributing goods and resources throughout an economy. throughout an economy.

Prices are almost always the most Prices are almost always the most efficient way to allocate or distribute efficient way to allocate or distribute resources. resources.

The alternative method – a centrally The alternative method – a centrally planned economy – is not nearly as planned economy – is not nearly as efficient. efficient.

Prices in a Free MarketPrices in a Free Market

Prices move land, labor, and capital Prices move land, labor, and capital into the hands of producers, and into the hands of producers, and finished goods into the hands of finished goods into the hands of consumersconsumers

How do we buy?How do we buy?

Prices in a Free MarketPrices in a Free Market

How do we shop? Comparison How do we shop? Comparison shopping? Have you ever shopping? Have you ever bought, then found a similar bought, then found a similar item for a better price and item for a better price and returned the first item?returned the first item?

Prices in the free market gives Prices in the free market gives us choices and allows us to us choices and allows us to “shop” for the best deals. “shop” for the best deals.

The Advantage of PricesThe Advantage of Prices

Prices provide a language for buyers Prices provide a language for buyers and sellers – a standard measure of and sellers – a standard measure of value.value.

Without prices, we’d have to barter Without prices, we’d have to barter for everything. for everything.

Price as an IncentivePrice as an Incentive

The laws of supply and demand The laws of supply and demand describe how people and firms describe how people and firms respond to a change in prices.respond to a change in prices.

Prices communicate to both buyers Prices communicate to both buyers and sellers whether goods are in and sellers whether goods are in short supply or readily available. short supply or readily available.

Prices as SignalsPrices as Signals

Prices as a traffic lightPrices as a traffic light

Prices as SignalsPrices as Signals(for Producers)(for Producers)

A relatively high price is a green light A relatively high price is a green light that tells producers that a specific that tells producers that a specific good is in demand and that they good is in demand and that they should produce more. New suppliers should produce more. New suppliers will also join the market.will also join the market.

Prices as SignalsPrices as Signals(for Producers)(for Producers)

A low price is a red light A low price is a red light to producers that a good to producers that a good is being overproduced. is being overproduced. Low prices tell a supplier Low prices tell a supplier that he or she might that he or she might earn higher profits by earn higher profits by using existing resources using existing resources to produce a different to produce a different product. product.

Prices as SignalsPrices as Signals(for Consumers)(for Consumers)

For consumers, a low price is a green For consumers, a low price is a green light to buy more of a good.light to buy more of a good.

A high price is a red light to stop and A high price is a red light to stop and think carefully before buying. think carefully before buying.

FlexibilityFlexibility

Prices are flexible.Prices are flexible. When a supply shift of a demand When a supply shift of a demand

shift changes equilibrium in a shift changes equilibrium in a market, price and quantity supplied market, price and quantity supplied changes.changes.

Supply shock – is a sudden shortage Supply shock – is a sudden shortage of a good, such as gasoline or wheat, of a good, such as gasoline or wheat, which creates a problem of excess which creates a problem of excess demand because suppliers can no demand because suppliers can no longer meet the needs of consumers.longer meet the needs of consumers.

FlexibilityFlexibility

Solutions? Solutions? RationingRationing Raising prices – quickest way to resolve Raising prices – quickest way to resolve

excess demand. A quick rise in price excess demand. A quick rise in price will reduce quantity demanded to the will reduce quantity demanded to the same level as quantity supplied and same level as quantity supplied and avoid the problem of distribution. avoid the problem of distribution.

Price System is FreePrice System is Free

No cost to administer, unlike No cost to administer, unlike centrally planned economiescentrally planned economies

Free market pricing distributes goods Free market pricing distributes goods through millions of decisions made through millions of decisions made daily by consumers and suppliers. daily by consumers and suppliers.

A Wide Choice of GoodsA Wide Choice of Goods

One benefit of a free market One benefit of a free market economy is the diversity of goods economy is the diversity of goods and services available to consumers.and services available to consumers.

Price helps consumers make choices Price helps consumers make choices among similar goods.among similar goods.

A Wide Choice of GoodsA Wide Choice of Goods

Prices also allow Prices also allow producers to “target” the producers to “target” the audience they want to sell audience they want to sell to.to.

What about in a Centrally What about in a Centrally Planned Economy? Planned Economy?

Rationing and ShortageRationing and Shortage

Command economy examples?Command economy examples?

American examples? American examples?

The Black MarketThe Black Market

When people conduct business When people conduct business without regard for government without regard for government controls on price or quantity.controls on price or quantity.

Black markets allow consumers to Black markets allow consumers to pay more so they can buy a good pay more so they can buy a good when rationing makes it otherwise when rationing makes it otherwise unavailable.unavailable.

Such trade is illegal Such trade is illegal

Efficient Resource AllocationEfficient Resource Allocation

A market system, with its freely A market system, with its freely changing prices, ensures that changing prices, ensures that resources go to the uses that resources go to the uses that consumer’s value most highly.consumer’s value most highly.

Resource use will adjust to the Resource use will adjust to the changing demands of consumers.changing demands of consumers.

Prices and the Profit IncentivePrices and the Profit Incentive

Businesses prosper by finding out Businesses prosper by finding out what people want, and then what people want, and then providing it. This has proved to be a providing it. This has proved to be a more efficient system than any other more efficient system than any other that has been tried in the modern that has been tried in the modern era.era.

Problems with the MarketProblems with the Market

Imperfect competitionImperfect competition

If only a couple of firms are selling a If only a couple of firms are selling a product, there might not be enough product, there might not be enough competition to lower the market competition to lower the market price to the cost of production.price to the cost of production.

If only one firm sells a product, this If only one firm sells a product, this producer will usually charge a higher producer will usually charge a higher price because there is no price because there is no competition. competition.

Spillover costsSpillover costs

Externalities Externalities A cost imposed without A cost imposed without

compensation on third compensation on third parties by the production or parties by the production or consumption of other parties. consumption of other parties.

Example: A manufacturer Example: A manufacturer dumps toxic chemicals into a dumps toxic chemicals into a river, killing the fish sought river, killing the fish sought by sport fishers. by sport fishers.

Imperfect informationImperfect information

If buyers and sellers do not have If buyers and sellers do not have enough information to make enough information to make informed choices about a product, informed choices about a product, they may not make the choice that is they may not make the choice that is best for them. best for them.