Unit 3 Microeconomics: Prices and Markets Chapters 6.3 Economics Mr. Biggs

The Role of Prices Prices in the Free Market In a free market, prices are a tool for distributing goods and resources throughout the economy. Prices allow an efficient, flexible exchange of goods. Prices help move the factors of production into the hands of the producers and finished goods into the hands of buyers.

The Advantage of Prices Prices provide a language of exchange where producers can measure demand and consumers express demand for a product. Prices as an Incentive Prices tell buyers and sellers if goods are in short supply or readily available. Prices as Signals It signals producers to produce more or less and buyers to purchase more or less.

Flexibility Price System Is “Free” When a supply shift or a demand shift changes the equilibrium in the market, price and quantity supplied changes to solve the problem of too much demand (shortage) or too little demand (surplus). Supply shock - A sudden shortage of a good. Rationing - A system of allocating scarce goods and services using criteria other than price. For example, a sudden shortage of gasoline would send prices soaring and could lead to rationing. Price System Is “Free” Prices help goods flow through the economy without a central plan.

Rationing and Shortages A Wide Choice of Goods One of the benefits of a market-based economy is the diversity of goods and services consumers can buy. Rationing and Shortages Although goods in the Soviet Union were inexpensive, consumers could not always find them. Rationing and shortages of consumer goods were common. The Black Market The black market is an illegal market that often occurs in a ration system. Black market - When people conduct business without regard for government controls on price and quantity.

Efficient Resource Allocation The free market uses economic resources, land, labor and capital, efficiently by directing them to the goods and services that are most valued by consumers. Prices and the Profit Incentive The free market provides a profit incentive for firms to increase or decrease goods and services based on consumer demand. The Wealth of Nations Adam Smith’s famous book, The Wealth of Nations, points out that businesses find out what consumers want and provide it for a profit.

Market Problems There are some exceptions to the general idea that markets lead to an efficient allocation of resources: 1) Imperfect competition, where only a few firms are selling a product. 2) Spill over costs or externalities - Costs of production that affect people who have no control over how much of a good is produced. For example, air pollution. 3) Imperfect information, where buyers and sellers do not have enough information to make an informed choice about a product. For example, buying a car.

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