HOLT: Economics Chapter 5 Prices “These documents are being distributed for educational discussion purposes only.  They do not reflect any attempt by the North East Independent School District, its trustees, administrators, or teachers, to promote any particular viewpoints or opinions expressed in the documents over any others, nor do the viewpoints or opinions expressed in the documents necessarily reflect those of the NEISD, its trustees, administrators or teachers.”

Section 1: The Price System Producers and consumers have different goals in the market due to self-interests Producers must attempt to find the level of production that satisfies consumers’ desires for affordable goods and their own desires to make a profit We are going to examine how the price system works in a free-enterprise system

The Language of Prices Producers communicate to consumers by saying “if you want this product, this is what you will have to pay” Consumers communicate to producers by saying “I want this product (or I don’t want this product) by buying or not buying the product

Benefits of the Price System Using the price system to communicate between producers and consumers provides…. Information Incentives Choice Efficiency Flexibility

Information Producers must know the prices of resources so they will be able to decide if the product they make is profitible Consumers must know the prices of goods and services to make informed buying decisions Prices inform consumers of the relative worth of the goods and services they purchase

Incentives In Ch. 2 we learned that incentives are something that encourages us to behave in a particular way High prices combined with low costs encourage producers to supply more goods and services Low prices give consumers an incentive to buy more goods and services

Choice The price system increases choices available in the market By competing with one another, manufacturers create hundreds of different products trying to match consumer preferences and generate the most profit

Efficiency The price system encourages efficiency by quickly delivering information to producers and consumers The pricing system tells producers how best to use their resources-natural, human, capital, & entrepreneurial-to meet consumer demand Consumers can easily compare one product to another by evaluating it’s price

Flexibility The market is able to adapt very quickly to high demand for popular items Clothing styles etc. from a popular movie Low supply of food caused by adverse weather conditions cause a rise in price which “rations” goods to those that will pay the higher price Oranges, coffee, etc.

Limitations of the Price System Normally the price system is an efficient way of distributing goods and services in a free enterprise system Sometimes goods/services are not distributed according to the normal pricing systems These limitations on the price system are called market failures

Externalities Sometimes the production of a good has side effects that effect people who are neither the producer or consumer of a particular product The side effects are called externalities and can be either positive or negative

Negative Externalities A negative externality exists when someone who does not make or consume a product has to bear part of the cost of production Pollution is an example of a negative externality The cost of a good created by a factory that pollutes is not entirely reflected in its price A price is “paid” by those who live near the factory and not the people who consume it’s product

Positive Externalities A positive externality is when someone who does not buy or sell a product benefits from its production Ex: A restaurant that is located close to a factory benefits from all of the factory workers who eat there

Public Goods A public good is any good or service consumed by all members of a group Ex. National defense, the judicial system, law enforcement, fire departments, streets, parks, schools If the government did not require people to pay for these through taxes, some of the people who benefit from them would be unwilling to pay

Instability The market can sometimes adapt to conditions like severe weather, natural disasters, etc. very quickly which can cause the pricing system to be unstable Prices can swing quickly to extremes Drastic drops in prices can cause some companies to go out of business Drastic increases in prices can make things so expensive people cannot afford them

Sec. 2: Determining Prices The price system is an unspoken language that influences decisions made by producers and consumers It determines the amount and prices of goods and services available in the market place

Equilibrium Market Equilibrium is when quantity supplied and quantity demanded is equal at the same price The needs of both producers and consumers are satisfied and the forces of supply and demand are in balance

Graphing Equilibrium Prices You can see the equilibrium point for a product by plotting its demand and supply curves on the same schedule or graph

Equilibrium: Fact or Theory This process contains a lot of trial and error True equilibrium is never reached Producers change prices and adjust production in an attempt to reach a balance The trial and error adjustments can cause either surpluses or shortages

Surpluses A surplus exists when the quantity supplied exceeds the quantity demanded at the price offered Surpluses tell producers that they are changing too much for their product Producers get rid of surpluses by lowering prices (can they still make a profit?) Lower prices makes consumers demand more

Shortages A shortage is when quantity demanded is greater than quantity supplied at a price This communicates to producers that they are charging too little for their product They can raise the price This steers the market toward equilibrium Either surpluses or shortages can lead to losses by manufacturers

In Balance Market equilibrium causes neither a surplus or a shortage

Graphing Trial and Error Surpluses and shortages can be shown on a graph to illustrate what happens as price determinations go through trial and error stages

Shifts in Equilibrium Ch. 3 & 4 described things that can affect supply/demand over time From the demand side (consumers): consumer tastes and preferences, market size, price of related goods, income, & consumer expectations can all change From the supply side (producers): government actions, technology, competition, producer expectations, and prices of resources and related goods can all change

Equilibrium, Demand, & Supply Shifts New equilibrium prices can result from the changes on the previous slide It can go up or down

Sec. 3: Managing Prices To keep the market functioning smoothly and to avoid instability caused by dramatic price swings, governments at times may choose to set prices and ration goods In an attempt to protect producers and consumers from dramatic price swings, governments sometimes implement price ceilings and price floors

Price Ceilings A price ceiling is a government regulation that establishes a maximum price for a particular good Producers cannot charge prices above this set level Ex. Rent controls In large cities high demand for rental apartments and homes drives prices higher Price controls are imposed by cities to make housing affordable for those who work and live in the cities

Price Floors A price floor is a government regulation that establishes a minimum level for prices Ex. Prices for agricultural products are controlled so farmers can continue to grow food which is in the national interest Ex. Minimum wage laws set the lowest amount an employer can legally pay a worker for a job ($7.25, 7/09)

Consequences of Setting Prices Interfering in the normal reaction of demand and supply can cause problems Price ceilings tend to cause shortages Price floors tend to create surpluses

Price Ceilings and Shortages Price ceilings like rent controls results in affordable housing Rents are kept artificially low so landlords cannot make enough profit Discourages building new units Discourages maintenance and repair Creates slums

Price Floors and Surpluses Price floors can create surpluses of goods To the right is a sample graph showing the equilibrium price for corn and its price floor

Rationing Sometimes the supply of a good is so low that the government rations the good Rationing is a system in which a government or other institution decides how to distribute a product In war times the government has rationed tires, gasoline, meat, butter, & coffee Rationing coupons

Non-Government Rationing Sporting events Concerts

Consequences of Rationing Many people say that rationing is an unwise policy. They say that …. It is unfair It is expensive It creates black markets

Unfairness of Rationing Prices should not favor one person or group over another All consumers should be treated equally

Cost of Rationing Rationing has high administrative costs Governments must decide who gets rationed goods and what amounts they get They must print and distribute rationing coupons They must enforce/control WW 2

Rationing Encourages Black Markets Black Markets are when goods are exchanged illegally at prices that are higher than officially established prices Rationing encourages black markets because while distributing goods among consumers, it does not satisfy consumer demand

What Is Wrong With Black Markets? Unfair; causes you to pay more for a good than if they were bought with a ration ticket Fake coupon sales causes consumers to lose money, unscrupulous cons It defeats the purpose of rationing; Determining which consumers receive how much of a good

Holt Economics; Texas Edition: 2003, Holt, Rinehart and Winston, References Holt Economics; Texas Edition: 2003, Holt, Rinehart and Winston,