1. HOLT: Economics Chapter 5
Prices
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2. Section 1: The Price System
Producers and consumers have different goals in the market due to self-interests
Producers must attempt to find the level of production that satisfies consumers’ desires for affordable goods and their own desires to make a profit
We are going to examine how the price system works in a free-enterprise system

3. The Language of Prices
Producers communicate to consumers by saying “if you want this product, this is what you will have to pay”
Consumers communicate to producers by saying “I want this product (or I don’t want this product) by buying or not buying the product

4. Benefits of the Price System
Using the price system to communicate between producers and consumers provides….
Information
Incentives
Choice
Efficiency
Flexibility

5. Information
Producers must know the prices of resources so they will be able to decide if the product they make is profitible
Consumers must know the prices of goods and services to make informed buying decisions
Prices inform consumers of the relative worth of the goods and services they purchase

6. Incentives
In Ch. 2 we learned that incentives are something that encourages us to behave in a particular way
High prices combined with low costs encourage producers to supply more goods and services
Low prices give consumers an incentive to buy more goods and services

7. Choice The price system increases choices available in the market
By competing with one another, manufacturers create hundreds of different products trying to match consumer preferences and generate the most profit

8. Efficiency
The price system encourages efficiency by quickly delivering information to producers and consumers
The pricing system tells producers how best to use their resources-natural, human, capital, & entrepreneurial-to meet consumer demand
Consumers can easily compare one product to another by evaluating it’s price

9. Flexibility
The market is able to adapt very quickly to high demand for popular items
Clothing styles etc. from a popular movie
Low supply of food caused by adverse weather conditions cause a rise in price which “rations” goods to those that will pay the higher price
Oranges, coffee, etc.

10. Limitations of the Price System
Normally the price system is an efficient way of distributing goods and services in a free enterprise system
Sometimes goods/services are not distributed according to the normal pricing systems
These limitations on the price system are called market failures

11. Externalities
Sometimes the production of a good has side effects that effect people who are neither the producer or consumer of a particular product
The side effects are called externalities and can be either positive or negative

12. Negative Externalities
A negative externality exists when someone who does not make or consume a product has to bear part of the cost of production
Pollution is an example of a negative externality
The cost of a good created by a factory that pollutes is not entirely reflected in its price
A price is “paid” by those who live near the factory and not the people who consume it’s product

13. Positive Externalities
A positive externality is when someone who does not buy or sell a product benefits from its production
Ex: A restaurant that is located close to a factory benefits from all of the factory workers who eat there

14. Public Goods
A public good is any good or service consumed by all members of a group
Ex. National defense, the judicial system, law enforcement, fire departments, streets, parks, schools
If the government did not require people to pay for these through taxes, some of the people who benefit from them would be unwilling to pay

15. Instability
The market can sometimes adapt to conditions like severe weather, natural disasters, etc. very quickly which can cause the pricing system to be unstable
Prices can swing quickly to extremes
Drastic drops in prices can cause some companies to go out of business
Drastic increases in prices can make things so expensive people cannot afford them

16. Sec. 2: Determining Prices
The price system is an unspoken language that influences decisions made by producers and consumers
It determines the amount and prices of goods and services available in the market place

17. Equilibrium
Market Equilibrium is when quantity supplied and quantity demanded is equal at the same price
The needs of both producers and consumers are satisfied and the forces of supply and demand are in balance

18. Graphing Equilibrium Prices
You can see the equilibrium point for a product by plotting its demand and supply curves on the same schedule or graph

19. Equilibrium: Fact or Theory
This process contains a lot of trial and error
True equilibrium is never reached
Producers change prices and adjust production in an attempt to reach a balance
The trial and error adjustments can cause either surpluses or shortages

20. Surpluses
A surplus exists when the quantity supplied exceeds the quantity demanded at the price offered
Surpluses tell producers that they are changing too much for their product
Producers get rid of surpluses by lowering prices (can they still make a profit?)
Lower prices makes consumers demand more

21. Shortages
A shortage is when quantity demanded is greater than quantity supplied at a price
This communicates to producers that they are charging too little for their product
They can raise the price
This steers the market toward equilibrium
Either surpluses or shortages can lead to losses by manufacturers

22. In Balance
Market equilibrium causes neither a surplus or a shortage

23. Graphing Trial and Error
Surpluses and shortages can be shown on a graph to illustrate what happens as price determinations go through trial and error stages

24. Shifts in Equilibrium
Ch. 3 & 4 described things that can affect supply/demand over time
From the demand side (consumers): consumer tastes and preferences, market size, price of related goods, income, & consumer expectations can all change
From the supply side (producers): government actions, technology, competition, producer expectations, and prices of resources and related goods can all change

25. Equilibrium, Demand, & Supply Shifts
New equilibrium prices can result from the changes on the previous slide
It can go up or down

26. Sec. 3: Managing Prices
To keep the market functioning smoothly and to avoid instability caused by dramatic price swings, governments at times may choose to set prices and ration goods
In an attempt to protect producers and consumers from dramatic price swings, governments sometimes implement price ceilings and price floors

27. Price Ceilings
A price ceiling is a government regulation that establishes a maximum price for a particular good
Producers cannot charge prices above this set level
Ex. Rent controls
In large cities high demand for rental apartments and homes drives prices higher
Price controls are imposed by cities to make housing affordable for those who work and live in the cities

28. Price Floors
A price floor is a government regulation that establishes a minimum level for prices
Ex. Prices for agricultural products are controlled so farmers can continue to grow food which is in the national interest
Ex. Minimum wage laws set the lowest amount an employer can legally pay a worker for a job ($7.25, 7/09)

29. Consequences of Setting Prices
Interfering in the normal reaction of demand and supply can cause problems
Price ceilings tend to cause shortages
Price floors tend to create surpluses

30. Price Ceilings and Shortages
Price ceilings like rent controls results in affordable housing
Rents are kept artificially low so landlords cannot make enough profit
Discourages building new units
Discourages maintenance and repair
Creates slums

31. Price Floors and Surpluses
Price floors can create surpluses of goods
To the right is a sample graph showing the equilibrium price for corn and its price floor

32. Rationing
Sometimes the supply of a good is so low that the government rations the good
Rationing is a system in which a government or other institution decides how to distribute a product
In war times the government has rationed tires, gasoline, meat, butter, & coffee
Rationing coupons

33. Non-Government Rationing
Sporting events
Concerts

34. Consequences of Rationing
Many people say that rationing is an unwise policy. They say that ….
It is unfair
It is expensive
It creates black markets

35. Unfairness of Rationing
Prices should not favor one person or group over another
All consumers should be treated equally

36. Cost of Rationing Rationing has high administrative costs
Governments must decide who gets rationed goods and what amounts they get
They must print and distribute rationing coupons
They must enforce/control
WW 2

37. Rationing Encourages Black Markets
Black Markets are when goods are exchanged illegally at prices that are higher than officially established prices
Rationing encourages black markets because while distributing goods among consumers, it does not satisfy consumer demand

38. What Is Wrong With Black Markets?
Unfair; causes you to pay more for a good than if they were bought with a ration ticket
Fake coupon sales causes consumers to lose money, unscrupulous cons
It defeats the purpose of rationing; Determining which consumers receive how much of a good

39. Holt Economics; Texas Edition: 2003, Holt, Rinehart and Winston,
References
Holt Economics; Texas Edition: 2003, Holt, Rinehart and Winston,