Prices

The Role of Prices In a free market, prices are a tool for distributing goods and resources throughout an economy. In a free market, prices are a tool for distributing goods and resources throughout an economy. Prices are almost always the most efficient way to allocate or distribute resources. Prices are almost always the most efficient way to allocate or distribute resources. The alternative method – a centrally planned economy – is not nearly as efficient. The alternative method – a centrally planned economy – is not nearly as efficient.

Prices in a Free Market Prices move land, labor, and capital into the hands of producers, and finished goods into the hands of consumers Prices move land, labor, and capital into the hands of producers, and finished goods into the hands of consumers How do we buy? How do we buy?

Prices in a Free Market How do we shop? Comparison shopping? Have you ever bought, then found a similar item for a better price and returned the first item? How do we shop? Comparison shopping? Have you ever bought, then found a similar item for a better price and returned the first item? Prices in the free market gives us choices and allows us to “shop” for the best deals. Prices in the free market gives us choices and allows us to “shop” for the best deals.

The Advantage of Prices Prices provide a language for buyers and sellers – a standard measure of value. Prices provide a language for buyers and sellers – a standard measure of value. Without prices, we’d have to barter for everything. Without prices, we’d have to barter for everything.

Price as an Incentive The laws of supply and demand describe how people and firms respond to a change in prices. The laws of supply and demand describe how people and firms respond to a change in prices. Prices communicate to both buyers and sellers whether goods are in short supply or readily available. Prices communicate to both buyers and sellers whether goods are in short supply or readily available.

Prices as Signals Prices as a traffic light

Prices as Signals (for Producers) A relatively high price is a green light that tells producers that a specific good is in demand and that they should produce more. New suppliers will also join the market. A relatively high price is a green light that tells producers that a specific good is in demand and that they should produce more. New suppliers will also join the market.

Prices as Signals (for Producers) A low price is a red light to producers that a good is being overproduced. Low prices tell a supplier that he or she might earn higher profits by using existing resources to produce a different product. A low price is a red light to producers that a good is being overproduced. Low prices tell a supplier that he or she might earn higher profits by using existing resources to produce a different product.

Prices as Signals (for Consumers) For consumers, a low price is a green light to buy more of a good. For consumers, a low price is a green light to buy more of a good. A high price is a red light to stop and think carefully before buying. A high price is a red light to stop and think carefully before buying.

Flexibility Prices are flexible. Prices are flexible. When a supply shift of a demand shift changes equilibrium in a market, price and quantity supplied changes. When a supply shift of a demand shift changes equilibrium in a market, price and quantity supplied changes. Supply shock – is a sudden shortage of a good, such as gasoline or wheat, which creates a problem of excess demand because suppliers can no longer meet the needs of consumers. Supply shock – is a sudden shortage of a good, such as gasoline or wheat, which creates a problem of excess demand because suppliers can no longer meet the needs of consumers.

Flexibility Solutions? Solutions? Rationing Rationing Raising prices – quickest way to resolve excess demand. A quick rise in price will reduce quantity demanded to the same level as quantity supplied and avoid the problem of distribution. Raising prices – quickest way to resolve excess demand. A quick rise in price will reduce quantity demanded to the same level as quantity supplied and avoid the problem of distribution.

Price System is Free No cost to administer, unlike centrally planned economies No cost to administer, unlike centrally planned economies Free market pricing distributes goods through millions of decisions made daily by consumers and suppliers. Free market pricing distributes goods through millions of decisions made daily by consumers and suppliers.

A Wide Choice of Goods One benefit of a free market economy is the diversity of goods and services available to consumers. One benefit of a free market economy is the diversity of goods and services available to consumers. Price helps consumers make choices among similar goods. Price helps consumers make choices among similar goods.

A Wide Choice of Goods Prices also allow producers to “target” the audience they want to sell to. Prices also allow producers to “target” the audience they want to sell to. What about in a Centrally Planned Economy? What about in a Centrally Planned Economy?

Rationing and Shortage Command economy examples? Command economy examples? American examples? American examples?

The Black Market When people conduct business without regard for government controls on price or quantity. When people conduct business without regard for government controls on price or quantity. Black markets allow consumers to pay more so they can buy a good when rationing makes it otherwise unavailable. Black markets allow consumers to pay more so they can buy a good when rationing makes it otherwise unavailable. Such trade is illegal Such trade is illegal

Efficient Resource Allocation A market system, with its freely changing prices, ensures that resources go to the uses that consumer’s value most highly. A market system, with its freely changing prices, ensures that resources go to the uses that consumer’s value most highly. Resource use will adjust to the changing demands of consumers. Resource use will adjust to the changing demands of consumers.

Prices and the Profit Incentive Businesses prosper by finding out what people want, and then providing it. This has proved to be a more efficient system than any other that has been tried in the modern era. Businesses prosper by finding out what people want, and then providing it. This has proved to be a more efficient system than any other that has been tried in the modern era.

Problems with the Market

Imperfect competition If only a couple of firms are selling a product, there might not be enough competition to lower the market price to the cost of production. If only a couple of firms are selling a product, there might not be enough competition to lower the market price to the cost of production. If only one firm sells a product, this producer will usually charge a higher price because there is no competition. If only one firm sells a product, this producer will usually charge a higher price because there is no competition.

Spillover costs Externalities Externalities A cost imposed without compensation on third parties by the production or consumption of other parties. A cost imposed without compensation on third parties by the production or consumption of other parties. Example: A manufacturer dumps toxic chemicals into a river, killing the fish sought by sport fishers. Example: A manufacturer dumps toxic chemicals into a river, killing the fish sought by sport fishers.

Imperfect information If buyers and sellers do not have enough information to make informed choices about a product, they may not make the choice that is best for them. If buyers and sellers do not have enough information to make informed choices about a product, they may not make the choice that is best for them.