1. Prices and Decision Making

2. Jump Start Chapter 6 section 1
Prices perform the allocation function well because they do all of the following :
Provide neutrality, favoring neither the producer or consumer
Provide flexibility, absorbing unexpected shocks
Enable the government to use rationing
Provide ways for consumers to make decisions
All of the following are characteristics of rationing except
Rationing is often viewed as unfair
Rationing creates high administrative cost
Rationing decreases the incentive to work
Rationing provides an efficient link between producers and consumers
In a market economy, a high price is a signal for
Producers to produce more and buyers to buy less
Producers to produce more and buyers to buy more
Producers to produce less and buyers to buy less
Producers to produce less and buyers to buy more
In a market economy, a low price is a signal for
Economist think of prices as a “system” because
They help buyers and sellers allocate resources between markets
They convey information to the government
They convey information to other countries
They make rationing necessary at times

3. Price
The monetary value of a product as established by supply and demand
Signals:
High prices: producers to produce more and for buyers to buy less
Low prices: producers to produce less and for buyers to buy more

4. Advantages of Prices Prices
help decide: WHAT, HOW, AND FOR WHOM
Prices are neutral in a competitive market economy
Result of competition b/w buyers and sellers:
More competitive = more efficient price adjustment process

5. Advantages of Prices Prices are flexible in a market economy
Think about computers THEN and NOW
Allows for the “SHOCK” of unforeseen events and changes in the market
Prices have no administration cost
Competitive markets find their own prices w/out interference
Prices change from one level to another gradually

6. Advantages of Prices Prices are familiar and easily understood
Mommy “I want a candy bar!”
You “Can I purchase that TV?”
No ambiguity: if it is $1 then you know you will pay $1 (plus tax in some states)
Make quick decisions
Minimum effort

7. Allocations Without Prices
Help us make economic decisions that “allocate” scarce resources and the product made from them
What if the PRICE SYSTEM did not exist?
Like command economies
Use another system right?

8. Allocations Without Prices
Rationing:
System where the government decides everyone’s “FAIR” share
RATION COUPON:
Obtain a certain allotted amount
Widely used during wartime
Questions of Fairness?
High Administrative cost
Diminishes incentives

9. Price as a System Economists favor the price system
Serve as signals that help allocate resources between markets
Oil ($5 to $40 a barrel in 1970’s)
Oil is inelastic
Higher energy cost = less money to spend elsewhere
1ST affected full size automobiles
Gave rebates: a partial refund of the original price of the product
Closed plants, laid off workers, started to change to small production

10. Price as a System Higher prices on oil = shift in productive resources
Prices help buyers and sellers allocate resources b/w markets
Economist think of the price as a system
Part of an informational network
Links all markets in the economy

11. Jump Start Chapter 6 section 1
Prices perform the allocation function well because they do all of the following Except :
Provide neutrality, favoring neither the producer or consumer
Provide flexibility, absorbing unexpected shocks
Enable the government to use rationing
Provide ways for consumers to make decisions
All of the following are characteristics of rationing except
Rationing is often viewed as unfair
Rationing creates high administrative cost
Rationing decreases the incentive to work
Rationing provides an efficient link between producers and consumers
In a market economy, a high price is a signal for
Producers to produce more and buyers to buy less
Producers to produce more and buyers to buy more
Producers to produce less and buyers to buy less
Producers to produce less and buyers to buy more
In a market economy, a low price is a signal for
Economist think of prices as a “system” because
They help buyers and sellers allocate resources between markets
They convey information to the government
They convey information to other countries
They make rationing necessary at times

14. The Price System at Work

15. Jump Start Chapter 6 section 2
In a competitive market, the adjustment process moves toward market
Equilibrium
Surplus
Shortage
Model
If there is a shortage in a market, the price is likely to
Increase
Decrease
Remain the same
Fluctuate
If there is a surplus in a market, the price is likely to
The theory of competitive pricing represents
A model by which to measure the performance of other less competitive markets
An important theory in economics
A set of ideal conditions and outcomes
All of the above
An economic model is described by all of the following except:
It is a set of assumptions that can be listed in a table, illustrated with a graph, or even stated algebraically
It can be used to help analyze behavior
It can be used to predict outcomes
It is usually so complex that is can be understood by economists

16. The Price Adjustment Process
Appealing feature of a Competitive Market Economy
EVERYONE who participates has a hand determining PRICES
Makes prices neutral and impartial
Buyers and sellers have exactly the OPPOSITE hopes and desire
Buyers = find good buys at low price
Sellers = high prices and large profits
Neither can get what they WANT so adjustments must be made

17. The Price Adjustment Process
Compromise needs to benefit BOTH parties
DEMAND and SUPPLY make a complete picture of the market
Price adjustments help a competitive market reach market equilibrium, with fairly equal supply and demand
See figure 6.1

18. Reflects the LAW OF DEMAND:
Consumers will buy more at lower prices and less at higher prices
Reflects the LAW OF SUPPLY:
Suppliers will offer more for sale at higher prices and less at lower ones

19. Represents the supply and demand sides of the market

20. SURPLUS= occurs when supply EXCEEDS demand
SHORTAGE= occurs when demand EXCEEDS supply

21. EQUILIBRUIM PRICE = occurs when supply MEETS demand

23. SURPLUS= occurs when supply EXCEEDS demand

24. Surplus Shows up as UNSOLD products on suppliers shelves
Takes up space
Know that the price is TOO high
NEED to LOWER the price to attract buyers
PRICES tend to go DOWN when there is a surplus

25. SHORTAGE= occurs when demand EXCEEDS supply

26. Shortage Suppliers have no more product to SELL
Wished they would have charged a higher price
Result = BOTH price and quantity supplied will go UP
We do not know how much PRICE will go up

28. EQUILIBRUIM PRICE = occurs when supply MEETS demand

29. Equilibrium Price
“Clears the market” neither a surplus nor a shortage at the end of the trading period
Economic Model of the market
CANNOT know how long it will take to reach
Price is set TOO HIGH the surplus will tend to force price down
Price is set TOO LOW the shortage will ten to force price up

30. Explaining and Predicting Prices
A change in price is the result of a
Change in Supply
Change in Demand
Or BOTH
Elasticity of Demand is also important when predicting prices

31. Explaining and Predicting Prices: Change in Supply
What causes change of supply with Agriculture?
Answer: ____________________________
See figure 6.3
SS = curve the farmer predicted
S1S1 = curve would move to if there was a record harvest
S2S2 = curve would move to if there was bad weather
Food is INELASTIC a small change in supply = large change in PRICE

32. Change in Supply

33. Explaining and Predicting Prices: Importance of Elasticity
Demand curve is MORE elastic
When a given change in supply occurs with an INELASTIC demand curve
PRICES change dramatically
When a change in supply occurs with an ELASTIC demand curve
Price change is smaller
BOTH supply and demand are INELASTIC = wider change in price
BOTH supply and demand are ELASTIC = less change in price

34. Importance of Elasticity

35. Explaining and Predicting Prices: Change in Demand
Changes in income, taxes, prices of related goods, expectations, and number of consumers
Example: GOLD

36. The Competitive Price Theory
The theory of competitive pricing represents a set of ideal conditions and outcomes; it serves as a model to measure market performance
Competitive market allocates resources efficiently
To be competitive:
Sellers are forced to lower prices
Find ways to keep cost down
Competition among buyers keeps prices from falling TOO far

37. Jump Start Chapter 6 section 2
In a competitive market, the adjustment process moves toward market
Equilibrium
Surplus
Shortage
Model
If there is a shortage in a market, the price is likely to
Increase
Decrease
Remain the same
Fluctuate
If there is a surplus in a market, the price is likely to
The theory of competitive pricing represents
A model by which to measure the performance of other less competitive markets
An important theory in economics
A set of ideal conditions and outcomes
All of the above
An economic model is described by all of the following except:
It is a set of assumptions that can be listed in a table, illustrated with a graph, or even stated algebraically
It can be used to help analyze behavior
It can be used to predict outcomes
It is usually so complex that is can be understood by economists