PRICES Chapter 5

In a free-enterprise market, prices are the main form of communication between producers and consumers.

Any time you buy a good or service, you are speaking the “Language” of prices – prices are the way in which producers tell consumers how much it costs to produce and distribute a good or service.

EXAMPLE The price of pizza tells the consumer, “If you want this amount of pizza, you have to pay this price.” If you buy the pizza, your response to producers is, “Yes, I want this amount of pizza at this price.” if you do not buy the pizza, your response is, “No, I do not want to buy this amount of pizza at this price.”

If consumers decide not to buy a product at the established price, producers must determine whether they can charge a lower price for the product and still make a profit.

MARKET EQUILIBRIUM A price system helps producers and consumers reach market equilibrium, a situation that occurs when the quantity supplied and the quantity demanded for a product are equal at the same price – at this point the needs for both the consumers and producers are satisfied.

EQUILIBRIUM POINT The equilibrium point can be shown for a product by plotting its demand and supply curves on the same graph.

SURPLUS A surplus exists when the quantity supplied exceeds the quantity demanded at the price offered – it tells producers that they are charging too much for their product.

SHORTAGE A shortage exists when the quantity demanded exceeds the quantity supplied at the price offered – it tells producers that they are charging too little for their product.

Remember, because markets change, demand and/or supply curves may shift to the right or the left – when one or both of the curves shifts, then the equilibrium price also changes.

Government sometimes set prices to protect producers and consumers from dramatic price swings – they accomplish this through two ways:

Price Ceilings – a government regulation that establishes a maximum price for a particular good – i.e. producers can not charge above this amount – tend to result in shortages. Ex.: rent control Price Floors – a government regulation that establishes a minimum level for prices – more common than price ceilings – tend to result in surpluses. Ex.: minimum wage