Price ___________ Favorite ___________ Qty Purchased ___________

Ch. 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 Benefits 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

Benefits 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 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 Black Friday @ Victoria's Secret

Supply and Demand The Market System makes certain that: - buyers can find the products they want -sellers are able to make a profit -sellers respond to changing wants/needs of buyers Supply and Demand work together bringing competing interests of buyers and sellers to a positive outcome

Balancing the Market Equilibrium Price- Market Equilibrium – When the market’s qty supplied and qty demanded are equal to each other and prices are relatively stable. At equilibrium the market is balanced. Equilibrium Price- The price of a good which clears the market of all goods without leaving a shortage or a surplus. At that price - buyers will buy exactly the qty that sellers are willing to supply.

Putting Supply and Demand Together!!! (I know you’ve been waiting your whole life for this moment!)

What if the price increases to $3? Supply and Demand are put together to determine equilibrium price and equilibrium quantity Supply Schedule Demand Schedule What if the price increases to $3? P Qty $3 350 $2.50 300 $2 250 $1.50 200 $1 150 $.50 100 P Qty $3 50 $2.50 100 $2 150 $1.50 200 $1 250 $.50 300 Equilibrium Price = $1.50 Equilibrium Qty = 200

Supply and Demand are no longer equal- Qty Supplied > Qty Demanded = Surplus Supply Schedule Demand Schedule P Qty $3 350 $2.50 300 $2 250 $1.50 200 $1 150 $.50 100 P Qty $3 50 $2.50 100 $2 150 $1.50 200 $1 250 $.50 300 New Price = $3 Surplus = 300 (QS-QD) = Surplus

What if the price decreases to $1? Disequilibrium cont. Surplus– occurs when qty supplied exceeds qty demanded. (AKA excess supply) Higher prices encourage sellers to provide more, but keeps buyers from buying – so there are a lot of left-overs. When there is a surplus, the sellers will lower prices and make less, gradually decreasing supply while increasing demand and equilibrium will be reached. What if the price decreases to $1?

Supply and Demand again not equal- Qty Demanded > Qty Supplied = Shortage Supply Schedule Demand Schedule P Qty $3 350 $2.50 300 $2 250 $1.50 200 $1 150 $.50 100 P Qty $3 50 $2.50 100 $2 150 $1.50 200 $1 250 $.50 300 New Price = $1 Shortage = 100 (QD-QS = Shortage

Disequilibrium When sellers see the # of people willing to buy, they -any point when qty supplied is not equal to qty demanded. Shortage– occurs when qty demanded is more than qty supplied. (AKA excess demand) Lower prices encourages buyers to buy, but discourages sellers to provide products When sellers see the # of people willing to buy, they will gradually raise their prices and supply more as prices go up- less people will be willing to pay and eventually equilibrium is reached

Markets and Equilibrium Market Forces will always push an unbalanced market towards equilibrium. Sellers do not want to waste resources by throwing out surplus goods. Sellers will also see excess demand as an opportunity to increase profits by raising prices. Sellers will change their prices and qty supplied in response to the buyers level of demand.

How to Analyze Shifting Supply and Demand Curves Assume shifts in supply or demand change equilibrium P and Q instantaneously

Easy as 1, 2, 3 Let’s Practice! Before the change: The change: Draw supply and demand Label original equilibrium price and quantity The change: Did it affect supply or demand first? (The answer is in the story) What caused the shift? Draw increase or decrease After change: Label new equilibrium? What happens to Price? (increase or decrease) What happens to Quantity? (increase or decrease) Let’s Practice!

Analyze Hamburgers S&D Analysis Practice Before Change (Draw equilibrium) The Change (S or D, Identify Shifter) After Change (Price and Quantity After) Analyze Hamburgers Price of sushi (a substitute) increases New grilling technology cuts production time in half Price of burgers falls from $3 to $1. Price for ground beef triples Human fingers found in multiple burger restaurants.

Double Shifts Suppose the demand for sports cars fell at the same time as production technology improved. Use S&D Analysis to show what will happen to PRICE and QUANTITY. If TWO curves shift at the same time, EITHER price or quantity will be indeterminate

Effects of Demand Elasticity When a supply shift happens and the good has inelastic demand, the change in qty demanded will be very small relative to the original data. When a supply shift happens and the good has elastic demand, the change in qty demanded will be much larger relative to the original data.