1. ECONOMICS CHAPTER 5, SECTION 1- THE PRICE SYSTEM

2. I. The Price System A. The price system allows producers and consumers to communicate to each other, balance supply and demand by compromising on production levels, and is relied upon by consumers and producers to answer the basic economic questions. B. There are benefits and limitations to the price system.

3. II. Benefits A. Information-Producers gather information about the cost of resources to produce their goods and services. Consumers gather information about prices to make informed purchasing decisions.

5. II. Benefits B. Incentives-High prices encourage producers to produce more goods and services. Low prices encourage consumers to purchase more goods and services.

7. II. Benefits C. Choice-High incentives encourage producers to increase the variety of goods and services they are producing. Consumers benefit by having a wide selection of goods and services from which to choose.

9. II. Benefits D. Efficiency-When producers know which goods and services consumers demand, they do not waste resources producing unwanted goods and services. Prices help consumers make decisions by eliminating options not available to them.

11. II. Benefits E. Flexibility-Natural disasters, trends, the weather, etc. can create demand for goods and services (very quickly, at times). Producers can raise prices to lower demand for goods and services or producers cannot raise prices and cause a shortage of goods and services

13. III. Limitations (market failures) A. Positive Externalities-This is when someone who does not buy or sell a good or service benefits from it. This is a failure because the price system fails to assign the entire cost of production to all those who benefit.

15. III. Limitations (market failures) B. Negative Externalities-This is when someone who does not buy or sell a good or service bears part of the cost of it. This is a failure because the price system fails to assign the entire cost of production to only the producers and consumers of the product.

17. III. Limitations (market failures) C. Public Goods-These are goods and services which are consumed (or may be consumed) by all members of a group. These are market failures because the price system fails to assign a cost of using the good/service to all consumers.

19. III. Limitations (market failures) D. Instability-The flexibility of the price system can cause prices to swing drastically high or drastically low. This is a failure because it causes producers and consumers to be unable to rely on stable prices when making decisions.