Chap. 6 Sect. 1 Prices as Signals Goals: List and explain the benefits of a price based market. Illustrate how a price-based market leads to more choices and greater efficiency. Analyze the problems that can occur without price-based markets. Explain the two roles of prices within the price system.

1) Provide a language for buyers and sellers to communicate Prices as a System Sam wants to buy his sister a sweater for her birthday – Cotton sweaters in the mall $20-$50 , Cashmere sweaters $110 - $350 He chooses a $25 cotton sweater based on his budget and sister’s taste Finds an almost identical sweater made out of acrylic yarn online for $20 with free shipping – buys it and returns the first one 2 Roles of Prices: 1) Provide a language for buyers and sellers to communicate 2) Distribute resources and goods through the economy Price based systems ensure that resources go towards the G & S that people value most, resources are not wasted on unwanted products

Distribution without Prices Rationing – dividing up goods based on criteria other than price, (need, equal #’s for all, etc) Rationing requires time and $ for organization & enforcement Rationing leads to bidding wars where the wealthy ultimately win, or to Black Markets where goods are bought and sold illegally at highly inflated prices Non-Price Based Systems have the following problems: Fairness Expensive Diminishing Incentives

4 Advantages of Prices -Neutral -”Free” -Familiar -Flexibility Prices are Neutral- Prices can encourage behavior from buyers and sellers but do not favor one over the other -Prices result from competition and are a compromise between buyers and sellers- better competition = efficient pricing Prices are “Free”– Price Changes do not require government intervention or administrative costs, they happen quickly & easily without having someone in charge

Advantages of Prices cont. Prices are Familiar- People understand how prices work and how to use them without special training Prices are Flexible – In many cases it is easier to change prices than to change levels of production Surpluses and shortages can be fixed faster with a price change than by lowering or increasing production of a good Raising prices will lower demand and bring new equilibrium quickly

Prices and Choice Market Based economies have lots of choices Thanks in part to price system Remember Sam and his sweater choices: Different prices reflect different levels of quality and materials Sellers can target different buyers by charging different prices (cashmere vs. cotton) Command Economies= extremely limited price ranges but the result is very limited choice, use rationing to control the distribution of goods – due to shortages U.S. gov’t used rations in WWII because of shortages in an effort to keep prices down – but most of the public was unhappy because of limited choice

Prices as Signals Producers : Green Light = High Prices - tell producers that a product is in demand encourages them to make more Red light = Low Prices – tell producers that there is a surplus and they should cut back production Buyers : Green Light = Low Prices – tell buyers that it is a bargain, they will tend to buy more Red light = High Prices – tell buyers to really consider the purchase and costs – tend to buy less

Goals: List and explain the benefits of a price based market. Illustrate how a price-based market leads to more choices and greater efficiency. Analyze the problems that can occur without price-based markets. Explain the two roles of prices within the price system.