Prices and Decision Making Chapter 6 Prices and Decision Making

6.1: Prices as Signals Explain how prices act as signals. Describe the advantages of using prices as a way to allocate economic products. Understand the difficulty of allocating scarce goods and services without using prices.

Vocab Price Rationing Ration Coupon Rebate

Introduction Life is full of signals that help us make decisions Ex when you pull up to an intersections you look at the stop light Turn signals But what signals help us with our economic decisions?

Price The monetary value of a product as established by supply and demand Signal that helps us make economic decisions

Prices communicate information and provide incentives to buyers and sellers High prices are signals for producers to produce more, buyers to buy less Low prices are signals for producers to produce less, buyers to buy more

Advantages of Prices Prices help to answer the 3 questions of WHAT, HOW, and FOR WHOM to produce 1) Prices are neutral because they don’t favor the buyer or the consumer. Result of competition 2) Prices are flexible, allowing for the “shocks” of unforeseen events and changes in the market 3) Prices have no administrative costs 4) Prices are familiar and easily understood

Allocations Without Prices What does it look like without prices? Rationing is an alternative system where the government decides everyone’s “fair” share Leads to the question of fairness People would receive a ration coupon, permit allowing holder to receive a given amount of a rationed product Commonly used during times of war by countries

Problems with rationing People feel their share is too small What is fair? Administrative cost of rationing Cost of making coupons, coupons being stolen/counterfeited Negative impact on the incentive to produce

Prices as a System Economists overwhelmingly favor prices systems Prices compromise a system that helps buyers and sellers allocate resources between markets Links all markets in the economy

Turn to a neighbor and discuss the following questions… In our opinion why does the neutrality of prices stimulate completion? Imagine that no matter how much you studied you were going to get a B in this class. How would this affect your incentive to study? *Write down your partner’s answer. Once you both have shared find a new partner to share your old partners answer with and vice versa.